Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 1 Multinational Financial Management: Opportunities and Challenges

1.1 The Global Financial Marketplace

1) Financial globalization has NOT resulted in:

A) continuing imbalances of balance of payments.

B) an increase in quantity and speed in the flow of capital across the world.

C) capital markets less open and a decrease in the availability of capital for many organizations.

D) uniform ways of ownership, control, and governance across the world.

Answer: D

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

2) Financial globalization has NOT resulted in:

A) continuing imbalances of balance of payments.

B) an increase in quantity and speed in the flow of capital across the world.

C) capital markets more open and an increase in the availability of capital for many

organizations.

D) an increase in the flow of capital into and out of industrialized markets.

Answer: C

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

3) The institutions of global finance are:

A) central banks.

B) commercial banks.

C) investment banks.

D) All of the above are institutions of global finance.

Answer: D

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

4) A well-established, large U.S.-based MNE will probably NOT be able to overcome which of

the following obstacles to maximizing firm value?

A) an open marketplace

B) high-quality strategic management

C) access to capital

D) none of the above

Answer: D

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Conceptual

AACSB: Application of knowledge

5) A well-established, large, China-based MNE will probably be most adversely affected by

which of the following elements of firm value?

A) an open marketplace

B) high-quality strategic management

C) access to capital

D) access to qualified labor pool

Answer: A

Diff: 2

L.O.: 1.1 The Global Financial Marketplace

Skill: Conceptual

AACSB: Application of knowledge

6) A well-established, large, Brazil-based MNE will probably be most adversely affected by

which of the following elements of firm value?

A) an open marketplace

B) high-quality strategic management

C) access to capital

D) access to qualified labor pool

Answer: C

Diff: 2

L.O.: 1.1 The Global Financial Marketplace

Skill: Conceptual

AACSB: Application of knowledge

7) A major cost avoided in the eurocurrency markets is the payment of deposit insurance fees,

such as:

A) Federal Deposit Insurance Corporation — FDIC.

B) Office of the Comptroller of the Currency — OCC.

C) International Monetary Fund — IMF.

D) World Bank — WB.

Answer: A

Diff: 2

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

8) The modern eurocurrency market was born shortly after:

A) World War II.

B) World War I.

C) Korean War.

D) Bosnian War.

Answer: A

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

9) The reference rate of interest in the eurocurrency market is the:

A) London Interbank Offered Rate.

B) Prima rate.

C) Federal funds rate.

D) Treasury rate.

Answer: A

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L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

10) Interest spreads in the eurocurrency market are small for many reasons EXCEPT:

A) Eurocurrency loans are secured loans.

B) Eurocurrency deposits and loans are made in amounts of $500,000 or more on an unsecured

basis.

C) The eurocurrency is a wholesale market.

D) Borrowers are usually large corporations or government entities.

Answer: A

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L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

11) Multinational enterprises (MNEs) are firms, both for-profit companies and not-for-profit

organizations, that have operations in more than one country, and conduct their business through

foreign subsidiaries, branches, or joint ventures with host country firms.

Answer: TRUE

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L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

12) Ownership, control, and governance changes radically across the world. The publicly traded

company is not the dominant global business organization—the privately held or family-owned

business is the prevalent structure—and their goals and measures of performance differ

dramatically.

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

13) The securities at the heart of the global capital markets are the Mortgage Backed Securities

(MBS). The health and security of the global financial system rely on the quality of these

securities.

Answer: FALSE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

14) The U.S. dollar has been the focal point of currency trading since the 1940s. As a result,

most of the world's currencies are quoted against the dollar.

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

15) Several of the world's major currency exchange rates follow a specific quotation convention

that is the result of tradition and history. The exchange rate between the U.S. dollar and the euro

is always quoted as "dollars per euro."

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

16) Several of the world's major currency exchange rates follow a specific quotation convention

that is the result of tradition and history. The exchange rate between the U.S. dollar and the

British pound is always quoted as "dollars per pound."

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

17) Several of the world's major currency exchange rates follow a specific quotation convention

that is the result of tradition and history. The exchange rate between the U.S. dollar and the

Japanese yen is always quoted as "dollars per Japanese yen."

Answer: FALSE

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L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

18) Your authors suggest that one way to characterize the global financial marketplace is through

its assets, institutions, and linkages.

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

19) Eurocurrencies are domestic currencies of one country on deposit in a second country.

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

20) A eurodollar deposit is a demand deposit.

Answer: FALSE

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Skill: Recognition

AACSB: Application of knowledge

21) Eurocurrency markets serve two valuable purposes: .1) Eurocurrency deposits are an

efficient and convenient money market device for holding excess corporate liquidity; and 2) the

Eurocurrency market is a major source of short-term bank loans to finance corporate working

capital needs, including the financing of imports and exports.

Answer: TRUE

Diff: 2

L.O.: 1.1 The Global Financial Marketplace

Skill: Conceptual

AACSB: Application of knowledge

22) The key factor attracting both depositors and borrowers to the Eurocurrency loan market is

the narrow interest rate spread within that market.

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Conceptual

AACSB: Application of knowledge

23) The Eurocurrency market continues to thrive because it is a large international money market

relatively free from governmental regulation and interference. Recent events may lead to greater

regulation.

Answer: TRUE

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Recognition

AACSB: Application of knowledge

24) The theme dominating global financial markets today is the complexity of risks associated

with financial globalization. List and explain examples of the complexity of risks affecting the

leading and managing of multinational firms in the rapidly moving marketplace.

Answer: The following is a sampling of this complexity of risks: 1) The international monetary

system is under constant scrutiny. The rise of the Chinese renminbi is changing much of the

world's outlook on currency exchange, reserve currencies, and the roles of the dollar and the

euro. 2) Large fiscal deficits, including the current eurozone crisis, plague most of the major

trading countries of the world, complicating fiscal and monetary policies, and ultimately, interest

rates and exchange rates. 3) Many countries experience continuing balance of payments

imbalances, and in some cases, dangerously large deficits and surpluses. 4) Ownership, control,

and governance vary radically across the world. 5) Global capital markets that normally provide

the means to lower a firm's cost of capital, and even more critically, increase the availability of

capital, have in many ways shrunk in size and have become less open and accessible to many of

the world's organizations. 6) Financial globalization has resulted in the ebb and flow of capital in

and out of both industrial and emerging markets, greatly complicating financial management.

Diff: 1

L.O.: 1.1 The Global Financial Marketplace

Skill: Conceptual

AACSB: Application of knowledge

25) Business involves the interaction of individuals and individual organizations for the

exchange of products, services, and capital through markets. The global capital markets are

critical for the conduct of this exchange. The authors suggest that one way to characterize the

global financial marketplace is through its assets, institutions, and linkages. Explain how each of

the three dimensions characterize the global financial marketplace.

Answer: 1) The financial assets at the heart of the global capital markets are the debt securities

issued by governments. These low-risk or risk-free assets (e.g., U.S. Treasury Bonds) form the

foundation for the creation, trading, and pricing of other financial assets like bank loans,

corporate bonds, and equities (stock). In recent years, a number of additional securities have

been created from existing securities-derivatives, whose value is based on market value changes

of the underlying securities. The health and security of the global financial system relies on the

quality of these assets. 2) The institutions of global finance are the central banks, which create

and control each country's money supply; the commercial banks, which take deposits and extend

loans to businesses, both local and global; and the multitude of other financial institutions

created to trade securities and derivatives. These institutions take many shapes and are subject to

many different regulatory frameworks. The health and security of the global financial system

relies on the stability of these financial institutions. 3) The links between the financial

institutions, the actual fluid or medium for exchange, are the interbank networks using currency.

The ready exchange of currencies in the global marketplace is the first and foremost necessary

element for the conduct of financial trading, and the global currency markets are the largest

markets in the world. The exchange of currencies, and the subsequent exchange of all other

securities globally via currency, is the international interbank network.

Diff: 2

L.O.: 1.1 The Global Financial Marketplace

Skill: Conceptual

AACSB: Application of knowledge

1.2 The Theory of Comparative Advantage

1) The theory that suggests specialization by country can increase worldwide production is:

A) the theory of comparative advantage.

B) the theory of foreign direct investment.

C) the international Fisher effect.

D) the theory of working capital management.

Answer: A

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT a reason governments interfere with comparative advantage?

A) Governments attempt to achieve full employment.

B) Governments promote economic development.

C) national self-sufficiency in defense-related industries

D) All are reasons governments interfere with comparative advantage.

Answer: D

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

3) Which of the following factors of production DO NOT flow freely between countries?

A) raw materials

B) financial capital

C) (non-military) technology

D) All of the above factors of production flow freely among countries.

Answer: A

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following would NOT be a way to implement comparative advantage?

A) IBM exports computers to Egypt.

B) Computer hardware is designed in the United States but manufactured and assembled in

Korea.

C) Water of the greatest purity is obtained from wells in Oregon, bottled, and exported

worldwide.

D) All of the above are examples of ways to implement comparative advantage.

Answer: D

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Conceptual

AACSB: Application of knowledge

5) Of the following, which would NOT be considered a way that government interferes with

comparative advantage?

A) tariffs

B) managerial skills

C) quotas

D) other non-tariff restrictions

Answer: B

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

6) The concept of absolute comparative advantage's origins lie in:

A) Adam Smith's work of 1776.

B) David Ricardo's work of 1776.

C) The Wealth of Nations book, published in 1887.

D) On the Principles of Political Economy and Taxation book, published in 1817.

Answer: A

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

7) The concept of relative comparative advantage's origins lie in:

A) Adam Smith's work of 1776.

B) David Ricardo's work of 1776.

C) The Wealth of Nations book, published in 1887.

D) On the Principles of Political Economy and Taxation book, published in 1817.

Answer: D

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

8) Comparative advantage is one of the underlying principles driving the growth of global

business.

Answer: TRUE

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

9) The theory of comparative advantage owes it origins to Ben Bernanke as described in his book

The Wealth of Bankers.

Answer: FALSE

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

10) International trade might have approached the comparative advantage model in the 19th

century, and it does so even more today.

Answer: FALSE

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

11) Comparative advantage shifts over time as less developed countries become more developed

and realize their latent opportunities.

Answer: TRUE

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

12) Comparative advantage in the 21st century is based more on services and their cross border

facilitation by telecommunications and the Internet.

Answer: TRUE

Diff: 1

L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

13) Comparative advantage was once the cornerstone of international trade theory, but today it is

archaic, simplistic, and irrelevant for explaining investment choices made by MNEs.

Answer: FALSE

Diff: 2

L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

14) When discussing comparative advantage, it is apparent that today at least two of the factors

of production, capital and technology, now flow directly and easily between countries, rather

than only indirectly through traded goods and services.

Answer: TRUE

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

15) It would be safe to make the statement that modern telecommunications now take business

activities to labor rather than moving labor to the places of business.

Answer: TRUE

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Conceptual

AACSB: Application of knowledge

16) As the general principle of comparative advantage is still valid, complete specialization

remains a realistic case.

Answer: FALSE

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L.O.: 1.2 The Theory of Comparative Advantage

Skill: Recognition

AACSB: Application of knowledge

17) Although international trade might have approached the comparative advantage model

during the nineteenth century, it certainly does not today, for a variety of reasons. Develop an

argument as to why this is not happening today.

Answer: Countries do not appear to specialize only in those products that could be most

efficiently produced by that country's particular factors of production. Instead, governments

interfere with comparative advantage for a variety of economic and political reasons, such as to

achieve full employment, economic development, national self-sufficiency in defense-related

industries, and protection of an agricultural sector's way of life. Government interference takes

the form of tariffs, quotas, and other non-tariff restrictions. The classical model of comparative

advantage also did not really address certain other issues such as the effect of uncertainty and

information costs, the role of differentiated products in imperfectly competitive markets, and

economies of scale.

Diff: 1

L.O.: 1.2 The Theory of Comparative Advantage

Skill: Conceptual

AACSB: Application of knowledge

1.3 What Is Different About International Financial Management?

1) Which of the following domestic financial instruments have NOT been modified for use in

international financial management?

A) currency options and futures

B) interest rate and currency swaps

C) letters of credit

D) All of the above are domestic financial instruments that have also been modified for use in

international financial markets.

Answer: D

Diff: 1

L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT always understood by MNE management?

A) culture, history, and institutions

B) political risk

C) foreign exchange risk

D) financial instruments

Answer: A

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

3) In determining why a firm becomes multinational there are many reasons. One reason is that

the firm is a market seeker. Which of the following is NOT a reason why market-seeking firms

produce in foreign countries?

A) satisfaction of local demand in the foreign country

B) to export to foreign markets

C) political safety and small likelihood of government expropriation of assets

D) All of the above are market-seeking activities.

Answer: C

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

4) ________ investments are designed to promote and enhance the growth and profitability of

the firm. ________ investments are designed to deny those same opportunities to the firm's

competitors.

A) Conservative; Aggressive

B) Defensive; Proactive

C) Proactive; Defensive

D) Aggressive; Proactive

Answer: C

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

5) In determining why a firm becomes multinational there are many reasons. One reason is that

the firm is a raw material seeker. Which of the following is NOT a reason why raw material

seeker extract raw materials in foreign countries?

A) They extract raw materials wherever they can be found to export from the host country.

B) They extract raw materials wherever they can be found for sale in the host country.

C) They extract raw materials wherever they can be found for further processing in the host

country.

D) All of the above.

Answer: D

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

6) MNEs must modify finance theories like cost of capital and capital budgeting because of

foreign complexities.

Answer: TRUE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

7) Relative to MNEs, purely domestic firms tend to have GREATER political risk.

Answer: FALSE

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L.O.: 1.3 What Is Different about International Financial Management?

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8) Domestic firms tend to make GREATER use of financial derivatives than MNEs because they

can bear the greater risk presented by these financial instruments.

Answer: FALSE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

9) Because countries have different financial regulations and customs, it is common for MNEs to

apply their domestic rules and regulations when doing financial business in a foreign country.

Answer: FALSE

Diff: 1

L.O.: 1.3 What Is Different about International Financial Management?

Skill: Conceptual

AACSB: Application of knowledge

10) A number of financial instruments that are used in domestic financial management have been

modified for use in international financial management. Examples are foreign currency options

and futures, interest rate and currency swaps, and letters of credit.

Answer: TRUE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

11) Domestic firms do not have foreign exchange risk.

Answer: FALSE

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L.O.: 1.3 What Is Different about International Financial Management?

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AACSB: Application of knowledge

12) Large international firms are better able to exploit product differentiation than are their local

competitors.

Answer: TRUE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

13) For firms competing in a world characterized by oligopolistic competition, strategic motives

can be subdivided into proactive and defensive investments.

Answer: TRUE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

14) Defensive measures are designed to enhance growth and profitability of the firm itself.

Answer: FALSE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

15) In determining why a firm becomes multinational there are many reasons. One reason is that

the firm is a knowledge seeker. They operate in foreign countries to exploit existing

technological expertise.

Answer: FALSE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

16) The five strategic motives driving the decision to invest abroad and become an MNE (market

seekers, raw material seekers, production efficiency seekers, knowledge seekers, and political

safety seekers) are mutually exclusive.

Answer: FALSE

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Recognition

AACSB: Application of knowledge

17) In the recent past, much of the business development in multinational firms was led by cross-

functional teams, teams of professionals who are competent over a broader array of functional

fields. Develop an argument as to why this is the case.

Answer: Teams are increasingly virtual and unique, each team custom-tailored for the business

proposal or opportunity, and often drawing upon the available talent across geographies,

markets, and cultures. Organizational agility, a phrase often used to describe decision-making

rather than the decision-makers, requires different skills. This require business professionals who

are fundamentally competent over a broader array of functional fields — and that would include

more than a passing of knowledge of multinational finance and how impacts investments and

operations. Knowledge of the financial dimensions of the business in the international business

environment is more and more a concern for all.

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L.O.: 1.3 What Is Different about International Financial Management?

Skill: Conceptual

AACSB: Application of knowledge

18) List and explain three strategic motives why firms become multinationals and give an

example of each.

Answer: The authors provide 5 strategic motives for firms to become multinationals: market

seekers, raw materials seekers, production efficiency seekers, knowledge seekers, and political

safety seekers. Market seekers are looking for more consumers for their products such as

automobiles or steel. Knowledge seekers may be looking for an educated work force similar to

the way firms seeking R and D set up shop in university towns. Raw materials seekers may be

after commodities such as oil or copper. Production efficiencies may occur in countries like

Mexico that have capable workers and lower wages. Political safety seekers are looking for

countries that will not expropriate their assets, so they may stay away from countries that in the

post have engaged in such activities.

Diff: 2

L.O.: 1.3 What Is Different about International Financial Management?

Skill: Conceptual

AACSB: Application of knowledge

1.4 The Globalization Process

1) The phase of the globalization process characterized by imports from foreign suppliers and

exports to foreign buyers is called the:

A) domestic phase.

B) multinational phase.

C) international trade phase.

D) import-export banking phase.

Answer: C

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

2) The authors describe the multinational phase of globalization for a firm as one characterized

by the:

A) ownership of assets and enterprises in foreign countries.

B) potential for international competitors or suppliers even though all accounts are with domestic

firms and are denominated in dollars.

C) imports from foreign suppliers and exports to foreign buyers.

D) requirement that all employees be multilingual.

Answer: A

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

3) A firm in the International Trade Phase of Globalization:

A) makes all foreign payments in foreign currency units and all foreign receipts in domestic

currency units.

B) receives all foreign receipts in foreign currency units and makes all foreign payments in

domestic currency units.

C) bears direct foreign exchange risk.

D) none of the above

Answer: C

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L.O.: 1.4 The Globalization Process

Skill: Conceptual

AACSB: Application of knowledge

4) Of the following, which was NOT mentioned by the authors as an increase in the demands of

financial management services due to increased globalization by the firm?

A) evaluation of the credit quality of foreign buyers and sellers

B) foreign consumer method of payment preferences

C) credit risk management

D) evaluation of foreign exchange risk

Answer: B

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

5) The twin agency problems limiting financial globalization are caused by these two groups

acting in their own self-interests rather than the interests of the firm.

A) rulers of sovereign states and unsavory customs officials

B) corporate insiders and attorneys

C) corporate insiders and rulers of sovereign states

D) attorneys and unsavory customs officials

Answer: C

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

6) Typically, a firm in its domestic stage of globalization has all financial transactions in its

domestic currency.

Answer: TRUE

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L.O.: 1.4 The Globalization Process

Skill: Conceptual

AACSB: Application of knowledge

7) Typically, a "greenfield" investment abroad is considered an investment having a greater

foreign presence than a joint venture with a foreign firm.

Answer: TRUE

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

8) The authors argue that financial inefficiency caused by influential insiders may prove to be an

increasingly troublesome barrier to international finance.

Answer: TRUE

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L.O.: 1.4 The Globalization Process

Skill: Conceptual

AACSB: Application of knowledge

9) The authors describe a process for development of a MNE that begins with a purely domestic

phase, followed by the multinational phase, and topping out with the international trade phase.

Answer: FALSE

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

10) Today it is widely assumed that there are NO LIMITS to financial globalization.

Answer: FALSE

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

11) The growth in the influence and self-enrichment of organizational insiders is seen as an

impediment to the growth of financial globalization in general.

Answer: TRUE

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L.O.: 1.4 The Globalization Process

Skill: Recognition

AACSB: Application of knowledge

12) Describe the structural and managerial changes and challenges experienced by a firm as it

moves its operations from domestic to global (globalization process).

Answer: A firm's initial strategy is to develop a sustainable competitive advantage in the U.S.

market (domestic phase). As firms becomes visible and viable competitors in the U.S. market,

strategic opportunities arise to expand the firm's market reach by exporting product and services

to one or more foreign markets and/or by importing inputs (international trade phase). If

companies are successful in their international trade activities, the time will come when the

globalization process will progress to the next phase. Companies will soon need to establish

foreign sales and service affiliates. This step is often followed by establishing manufacturing

operations abroad or by licensing foreign firms to produce and service (multinational phase).

Once companies own assets and enterprises in foreign countries, they have entered the

multinational phase of their globalization.

Diff: 3

L.O.: 1.4 The Globalization Process

Skill: Conceptual

AACSB: Application of knowledge

13) The objectives and responsibilities of the modern multinational have grown significantly

more complex in the twenty-first century. Develop and argument as to why this is the case.

Answer: It is accepted that the purpose of the corporation is to certainly create profits and value

for its stakeholders, but the responsibility of the corporation is to do so in a way that inflicts no

costs on society, including the environment. This developing controversy has been somewhat

hampered to date by conflicting terms and labels—corporate goodness, corporate responsibility,

corporate social responsibility (CSR), corporate philanthropy, and corporate sustainability, to list

but a few. Confusion can be reduced by using a guiding principle—that sustainability is a goal,

while responsibility is an obligation. It follows that the obligation of leadership in the modern

multinational is to pursue profit, social development, and the environment, all along sustainable

principles.

Diff: 2

L.O.: 1.4 The Globalization Process

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 2 The International Monetary System

2.1 History of the International Monetary System

1) Under the gold standard of currency exchange that existed from 1879 to 1914, an ounce of

gold cost $20.67 in U.S. dollars and £4.2474 in British pounds. Therefore, the exchange rate of

pounds per dollar under this fixed exchange regime was:

A) £4.8665/$.

B) £0.2055/$.

C) always changing because the price of gold was always changing.

D) unknown because there is not enough information to answer this question.

Answer: B

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Analytical

AACSB: Analytical thinking

2) World War I caused the suspension of the gold standard for fixed international exchange rates

because the war:

A) cost too much money.

B) interrupted the free movement of gold.

C) lasted too long.

D) used gold as the main ingredient in armament plating.

Answer: B

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

3) The post WWII international monetary agreement that was developed in 1944 is known as

the:

A) United Nations.

B) League of Nations.

C) Yalta Agreement.

D) Bretton Woods Agreement.

Answer: D

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

4) Another name for the International Bank for Reconstruction and Development is:

A) the Recon Bank.

B) the European Monetary System.

C) the Marshall Plan.

D) the World Bank.

Answer: D

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

5) The International Monetary Fund (IMF):

A) in recent years has provided large loans to Russia, South Korea, and Brazil.

B) was created as a result of the Bretton Woods Agreement.

C) aids countries with balance of payment and exchange rate problems.

D) is all of the above.

Answer: D

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

6) One of the innovations introduced by Bretton Woods was the creation of the Special Drawing

Right or SDR. The SDR is an international reserve asset created by the:

A) U.S. Department of the Treasury.

B) International Bank of Reconstruction and Development (IBRD).

C) World Bank (WB).

D) International Monetary Fund (IMF).

Answer: D

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

7) Which of the following led to the eventual demise of the fixed currency exchange rate regime

worked out at Bretton Woods?

A) widely divergent national monetary and fiscal policies among member nations

B) differential rates of inflation across member nations

C) several unexpected economic shocks to member nations

D) all of the above

Answer: D

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

8) Which of the following statements is NOT true?

A) The Gold Standard Era was characterized by growing openness in trade, but limited capital

mobility.

B) The time period between World Wars I and II (the inter war years) witnessed significant

reductions in trade barriers and a rapid acceleration in international trade.

C) The Bretton Woods Era (post WWII) realized the increasing benefits of open economies.

Furthermore, trade was increasingly dominated by capital.

D) Since March 1973, exchange rates have become much more volatile and less predictable than

previous periods.

Answer: B

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

9) A review of the evolution of the Global Monetary System shows that capital flows dominate

trade in which of the following eras EXCEPT:

A) Classical Gold Standard.

B) Fixed Exchange Rates, 1945-1973.

C) The Floating Era, 1973-1997.

D) The Emerging Era, 1997-Present.

Answer: A

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

10) Since 2009 the IMF's exchange rate regime classification system uses a "de facto

classification" methodology. Under this system, a country that has given up their own

sovereignty over monetary policy is considered to have:

A) a residual agreement.

B) hard pegs.

C) soft pegs.

D) floating arrangements.

Answer: B

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

11) Since 2009 the IMF's exchange rate regime classification system uses a "de facto

classification" methodology. Under this system, countries with "fixed exchange rates" are

considered to have:

A) a residual agreement.

B) soft pegs.

C) hard pegs.

D) floating arrangements.

Answer: B

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

12) A small economy country whose GDP is heavily dependent on trade with the United States

could use a(n) ________ exchange rate regime to minimize the risk to their economy that could

arise due to unfavorable changes in the exchange rate.

A) pegged exchange rate with the United States

B) pegged exchange rate with the Euro

C) independent floating

D) managed float

Answer: A

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Conceptual

AACSB: Application of knowledge

13) Since 2009 the IMF's exchange rate regime classification system uses a "de facto

classification" methodology. Under this system, currencies that are predominantly market-driven

are considered to be:

A) soft pegs.

B) hard pegs.

C) floating arrangements.

D) a residual agreement.

Answer: C

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

14) Among IMF member countries since 2010, the dominating exchange rate regime has been:

A) hard peg.

B) soft peg.

C) floating arrangements.

D) residual agreement.

Answer: B

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

15) Under the terms of Bretton Woods, countries tried to maintain the value of their currencies to

within 1% of a hybrid security made up of the U.S. dollar, British pound, and Japanese yen.

Answer: FALSE

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

16) Members of the International Monetary Fund may settle transactions among themselves by

transferring Special Drawing Rights (SDRs).

Answer: TRUE

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

17) Today, the United States has been ejected from the International Monetary Fund for refusal

to pay annual dues.

Answer: FALSE

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

18) From the time of its creation through September 2017, the euro peaked versus the USD in

April 2008 at around $1.60/€.

Answer: TRUE

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

19) Since March 1973, when exchange rates become more volatile and less predictable than

during the "fixed" exchange rate period, the nominal exchange rate index of the U.S. dollar

peaked in 2011.

Answer: FALSE

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

20) The euro is an example of a rigidly fixed system, acting as a single currency for its member

countries. However, the euro itself is an independently floating currency against all other

currencies.

Answer: TRUE

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

21) Although the contemporary international monetary system is typically referred to as a

"floating regime," it is clearly not the case for the majority of the world's nations.

Answer: TRUE

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

22) The IMF's methodology for classifying exchange rate regimes today is based on the official

policy statement of the respective governments, de jure classification.

Answer: FALSE

Diff: 1

L.O.: 2.1 History of the International Monetary System

Skill: Recognition

AACSB: Application of knowledge

23) Most Western nations were on the gold standard for currency exchange rates from 1876 until

1914. Today we have several different exchange rate regimes in use, but most larger economy

nations have freely floating exchange rates today and are not obligated to convert their currency

into a predetermined amount of gold on demand. Currently several parties still call for the "good

old days" and a return to the gold standard. Develop an argument as to why this is a good idea.

Answer: The gold standard forces a nation to maintain sufficient reserves of gold to back its

currency's value. This helps control inflation, as a country cannot print additional money without

sufficient gold to back it up. The gold standard eases international transactions as there is little

uncertainly about exchange rates for trade with foreign countries.

Diff: 3

L.O.: 2.1 History of the International Monetary System

Skill: Conceptual

AACSB: Application of knowledge

24) The mobility of international capital flows is causing emerging market nations to choose

between a free-floating currency exchange regime and a currency board (or taken to the limit,

dollarization). Describe how each of the regimes would work and identify at least two likely

economic results for each regime.

Answer: With free float the exchange rate is market determined and beyond the control of the

country's central bank or government. The economic results are likely to be an independent

monetary policy, free movement of capital, but less stability in the exchange rate. Such

instability may be more than an emerging market country's small financial market can bear. A

currency board on the other hand is an implied legislative commitment to fix the foreign

exchange rate with a specific currency, generally the country's major trading partner.

Dollarization is taking this policy to the extreme whereby the emerging market nation forgoes its

currency for that of its major trading partner. An example of Dollarization is Panama using U.S.

dollars as the official Panamanian currency. With such a regime, independent monetary policy is

lost and political influence on monetary policy is eliminated. However, the benefits accruing to

countries as a result of the ability to print its own money, seigniorage, is lost.

Diff: 2

L.O.: 2.1 History of the International Monetary System

Skill: Conceptual

AACSB: Application of knowledge

2.2 Fixed Versus Flexible Exchange Rates

1) Based on the premise that, other things equal, countries would prefer a fixed exchange rate,

which of the following statements is NOT true?

A) Fixed rates provide stability in international prices for the conduct of trade.

B) Fixed exchange rate regimes necessitate that central banks maintain large quantities of

international reserves for use in the occasional defense of the fixed rate.

C) Fixed rates are inherently inflationary in that they require the country to follow loose

monetary and fiscal policies.

D) Stable prices aid in the growth of international trade and lessen exchange rate risks for

businesses.

Answer: C

Diff: 2

L.O.: 2.2 Fixed Versus Flexible Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

2) According to the terminology associated with changes in currency values, which of the

following choices is the case when a currency's value relative to other currencies is changed by a

government?

A) depreciation and revaluation

B) devaluation and appreciation

C) devaluation and revaluation

D) depreciation and appreciation

Answer: C

Diff: 2

L.O.: 2.2 Fixed Versus Flexible Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

3) Based on the premise that, other things equal, countries would prefer a fixed exchange rate:

Variable rates provide stability in international prices for the conduct of trade.

Answer: FALSE

Diff: 1

L.O.: 2.2 Fixed Versus Flexible Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

4) If exchange rates were fixed, investors and traders would be relatively certain about the

current and near future exchange value of each currency.

Answer: TRUE

Diff: 1

L.O.: 2.2 Fixed Versus Flexible Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

5) According to the terminology associated with changes in currency values, depreciation is a

case when a currency's value relative to other currencies is changed by a government.

Answer: FALSE

Diff: 1

L.O.: 2.2 Fixed Versus Flexible Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

6) By and large, high capital mobility is forcing emerging market nations to choose between the

two extremes of a free-floating exchange rate or a hard peg regime.

Answer: TRUE

Diff: 1

L.O.: 2.2 Fixed Versus Flexible Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

2.3 The Impossible Trinity

1) Which of the following is NOT an attribute of the "ideal" currency?

A) monetary independence

B) full financial integration

C) exchange rate stability

D) All are attributes of an ideal currency.

Answer: D

Diff: 1

L.O.: 2.3 The Impossible Trinity

Skill: Conceptual

AACSB: Application of knowledge

2) The authors discuss the concept of the "Impossible Trinity" or the inability to achieve

simultaneously the goals of exchange rate stability, full financial integration, and monetary

independence. If a country chooses to have a pure float exchange rate regime, which two of the

three goals is a country most able to achieve?

A) monetary independence and exchange rate stability

B) exchange rate stability and full financial integration

C) full financial integration and monetary independence

D) A country cannot attain any of the exchange rate goals with a pure float exchange rate regime.

Answer: C

Diff: 2

L.O.: 2.3 The Impossible Trinity

Skill: Conceptual

AACSB: Application of knowledge

3) China today is a clear example of a nation that has chosen the following policies EXCEPT:

A) control and manage the value of its currency.

B) conduct an independent monetary policy.

C) full financial integration in an attempt to stimulate its domestic economy.

D) restrict the flow of capital into and out of the country.

Answer: C

Diff: 2

L.O.: 2.3 The Impossible Trinity

Skill: Conceptual

AACSB: Application of knowledge

4) List and explain the three attributes (often referred as the impossible trinity) an ideal currency

would possess if existed in today's world.

Answer: If the ideal currency existed in today's world, it would possess the following three

attributes, often referred to as the impossible trinity: 1) Exchange rate stability: the value of the

currency is fixed (and relatively certain) in relationship to other major currencies. 2) Full

financial integration: complete freedom of monetary flows would be allowed. 3) Monetary

independence: domestic monetary and interest rate policies would be set by each individual

country to pursue desired national economic policies. These qualities are termed the impossible

trinity because the forces of economics do not allow a country to simultaneously achieve all

three goals.

Diff: 1

L.O.: 2.3 The Impossible Trinity

Skill: Conceptual

AACSB: Application of knowledge

2.4 A Single Currency for Europe: The Euro

1) Which of the following is NOT a required convergence criterion to become a full member of

the European Economic and Monetary Union (EMU)?

A) National birthrates must be at 2.0 or lower per person.

B) The fiscal deficit should be no more than 3% of GDP.

C) Nominal inflation should be no more than 1.5% above the average inflation rate for the three

members with the lowest inflation rates in the previous year.

D) Government debt should be no more than 60% of GDP.

Answer: A

Diff: 2

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Recognition

AACSB: Application of knowledge

2) According to the authors, what is the single most important mandate of the European Central

Bank?

A) Promote international trade for countries within the European Union.

B) Price, in euros, all products for sale in the European Union.

C) Promote price stability within the European Union.

D) Establish an EMU trade surplus with the United States.

Answer: C

Diff: 2

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Conceptual

AACSB: Application of knowledge

3) Which of the following is a way in which the euro affects markets?

A) Countries within the Euro zone enjoy cheaper transaction costs.

B) Currency risks and costs related to exchange rate uncertainty are reduced.

C) Consumers and business enjoy price transparency and increased price-based competition.

D) all of the above

Answer: D

Diff: 1

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Conceptual

AACSB: Application of knowledge

4) For the three years from early 2002 to early 2005, the euro maintained a strong and steady rise

in value against the U.S. dollar (USD). After a brief respite in 2005, the euro continued its climb

against the USD into 2008. Which of the following were NOT a contributing factor in the assent

of the euro and the decline in the dollar?

A) severe U.S. balance of payments deficits

B) a general weakening of the dollar after the attacks of September 11, 2001

C) large U.S. balance of payment surpluses

D) All of the above were contributing factors.

Answer: C

Diff: 1

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Conceptual

AACSB: Application of knowledge

5) The countries that use the euro as their currency have:

A) agreed to use a single currency (exchange rate stability), allow the free movement of capital

in and out of their economies (financial integration), but give up individual control of their own

money supply (monetary independence).

B) gained control over their own money supply (monetary independence), allowed the free

movement of capital in and out of their economies (financial integration), but give up exchange

rate stability.

C) agreed to use a single currency (exchange rate stability), allow individual control of their own

money supply (monetary independence), but give up the free movement of capital in and out of

their economies (financial integration).

D) none of the above

Answer: A

Diff: 2

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Recognition

AACSB: Application of knowledge

6) The Euro currency is fixed against other currencies on the international currency exchange

markets, but allows member country currencies to float against each other.

Answer: FALSE

Diff: 1

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Recognition

AACSB: Application of knowledge

7) The European Central Bank is a strong and independent central bank that has completely

replaced the individual central banks of the countries that use the euro as their currency.

Answer: FALSE

Diff: 2

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Recognition

AACSB: Application of knowledge

8) The members of the EU do have relative freedom to set their own fiscal policies—government

spending, taxation, and the creation of government surpluses or deficits. They are expected to

keep deficit spending within limits.

Answer: TRUE

Diff: 2

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Recognition

AACSB: Application of knowledge

9) List and explain three benefits the euro would generate for the states participating in the

European Economic and Monetary Union.

Answer: The euro would generate a number of benefits for the participating states: 1) Countries

within the eurozone enjoy cheaper transaction costs; 2) Currency risks and costs related to

exchange rate uncertainty are reduced; and 3) All consumers and businesses both inside and

outside the eurozone enjoy price transparency and increased price-based competition. The

primary "cost" of adopting the euro, the loss of monetary independence.

Diff: 1

L.O.: 2.4 A Single Currency for Europe: The Euro

Skill: Conceptual

AACSB: Application of knowledge

2.5 Emerging Markets and Regime Choices

1) Beginning in 1991, Argentina conducted its monetary policy through a currency board. In

January 2002, Argentina abandoned the currency board and allowed its currency to float against

other currencies. The country took this step because:

A) the Argentine Peso had grown too strong against major trading powers thus the currency

board policies were hurting the domestic economy.

B) the United States required the action as a prerequisite to finalizing a free trade zone with all of

North, South, and Central America.

C) the Argentine government lost the ability to maintain the pegged relationship as in fact

investors and traders perceived a lack of equality between the Argentine Peso and the U.S.

dollar.

D) all of the above

Answer: C

Diff: 2

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

2) In January 2002, the Argentine Peso changed in value from Peso1.00/$ to Peso1.40/$; thus,

the Argentine Peso ________ against the U.S. dollar.

A) strengthened

B) weakened

C) remained neutral

D) all of the above

Answer: B

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Analytical

AACSB: Analytical thinking

3) In January 2000 Ecuador officially replaced its national currency, the Ecuadorian sucre, with

the U.S. dollar. This practice is known as:

A) bi-currencyism.

B) securitization

C) a Yankee bailout.

D) dollarization.

Answer: D

Diff: 2

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Conceptual

AACSB: Application of knowledge

4) You have been hired as a consultant to the central bank for a country that has for many years

suffered from repeated currency crises and depends heavily on the U.S. financial and product

markets. Which of the following policies would have the greatest effectiveness for reducing

currency volatility of the client country with the United States?

A) dollarization

B) an exchange rate pegged to the U.S. dollar

C) an exchange rate with a fixed price per ounce of gold

D) an internationally floating exchange rate

Answer: A

Diff: 2

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Conceptual

AACSB: Application of knowledge

5) Which of the following is NOT an argument against dollarization?

A) Dollarization causes a loss of sovereignty over domestic monetary policy.

B) Dollarization removes currency volatility against the dollar.

C) Dollarization causes the country to lose the power of seigniorage.

D) The central bank of the dollarized country loses the role of lender of last resort.

Answer: B

Diff: 2

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

6) The ability of a country to profit from its ability to print money is known as:

A) profiteering.

B) dollarization.

C) seigniorage.

D) inflation.

Answer: C

Diff: 2

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

7) Which of the following factors make it difficult for emerging market economies to choose a

specific currency regime?

A) weak fiscal, financial, and monetary institutions

B) the tendency for commerce to allow currency substitution and the denomination of liabilities

in dollars

C) the emerging market's vulnerability to sudden stoppages of outside capital flows

D) all of the above

Answer: D

Diff: 2

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Conceptual

AACSB: Application of knowledge

8) Of the following, which is NOT a trade-off that must be dealt with in any exchange rate

regime?

A) cooperation vs. independence

B) rules vs. discretionary action

C) dollars vs. pounds

D) All of the above are rate regime trade-offs.

Answer: C

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

9) The following are examples of degrees of internationalization of an international currency

EXCEPT:

A) First degree of internationalization is when an international currency becomes readily

accessible for trade.

B) A second degree of internationalization is when an international currency is used for

international investment.

C) A third degree of internationalization is when an international currency is used for

international investment.

D) A third degree of internationalization is when an international currency takes the role of a

reserve currency.

Answer: C

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

10) A currency board exists when a country's central bank commits to back its money supply

entirely with foreign reserves at all times.

Answer: TRUE

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

11) A currency board exists when a country's central bank commits to back a fraction of its

money base with foreign reserves at all times.

Answer: FALSE

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

12) Dollarization is a common solution for countries suffering from currency revaluation.

Answer: FALSE

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

13) All exchange rate regimes must deal with the trade-off between rules and discretion as well

as between cooperation and independence.

Answer: TRUE

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

14) Regime structures like the gold standard required no cooperative policies among countries,

only the assurance that all would abide by the "rules of the game."

Answer: TRUE

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Recognition

AACSB: Application of knowledge

15) Bretton Woods required less in the way of cooperation among countries than did the gold

standard.

Answer: FALSE

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Conceptual

AACSB: Application of knowledge

16) The People's Republic of China has two official currencies, the Chinese renminbi (RMB) and

the yuan (CNY).

Answer: FALSE

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Conceptual

AACSB: Application of knowledge

17) Dollarization is the use of the U.S. dollar as the official currency of the country. List and

explain the arguments for and against dollarization. Provide example/s of countries that used the

dollar as its official currency.

Answer: The arguments for dollarization are: 1) country that dollarizes removes any currency

volatility (against the dollar) and would theoretically eliminate the possibility of future currency

crises, 2) expectations of greater economic integration with other dollar-based markets, both

product and financial. This last point has led many to argue in favor of regional dollarization.

Three major arguments exist against dollarization. The first is the loss of sovereignty over

monetary policy. This is, however, the point of dollarization. Second, the country loses the

power of seigniorage, the ability to profit from its ability to print its own money. Third, the

central bank of the country, because it no longer has the ability to create money within its

economic and financial system, can no longer serve the role of lender of last resort. This role

carries with it the ability to provide liquidity to save financial institutions that may be on the

brink of failure during times of financial crisis.

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Conceptual

AACSB: Application of knowledge

18) Explain how all exchange rate regimes must deal with the trade-off between rules and

discretion, as well as between cooperation and independence. List and classified two

International Monetary Systems based on these four quadrants.

Answer: 1) Vertically, different exchange rate arrangements may dictate whether a country's

government has strict intervention requirements (rules) or if it may choose whether, when, and to

what degree to intervene in the foreign exchange markets (discretion). 2) Horizontally, the trade-

off for countries participating in a specific system is between consulting and acting in unison

with other countries (cooperation) or operating as a member of the system, but acting on their

own (independence).

Regime structures like the gold standard required no cooperative policies among countries, only

the assurance that all would abide by the "rules of the game." Under the gold standard, this

assurance translated into the willingness of governments to buy or sell gold at parity rates on

demand. The Bretton Woods Agreement, the system in place between 1944 and 1973, required

more in the way of cooperation, in that gold was no longer the "rule," and countries were

required to cooperate to a higher degree to maintain the dollar-based system. Exchange rate

systems, like the European Monetary System's (EMS) fixed exchange rate band system used

from 1979 to 1999, were hybrids of these cooperative and rule regimes.

Diff: 1

L.O.: 2.5 Emerging Markets and Regime Changes

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 3 The Balance of Payments

3.1 Fundamentals of BOP Accounting

1) Which of the following is NOT a major subaccount of the Balance of Payments?

A) the financial account

B) the accounts payable

C) the capital account

D) the current account

Answer: B

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following international transactions would NOT be counted as a balance of

payments (BOP) transaction?

A) An American tourist purchases cheese in Milwaukee, Wisconsin.

B) The U.S. subsidiary of a British firm pays profits (dividends) back to its parent firm in

London.

C) A Canadian lumber baron purchases a U.S. corporate bond through an investment broker in

Seattle.

D) All of the above are considered BOP transactions.

Answer: A

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

3) The balance of payments as applied to a course in international finance may be defined as:

A) the amount still owed by an exporting firm after making an initial down payment.

B) the amount still owed by governments to the International Monetary Fund.

C) the measurement of all international economic transactions between the residents of a country

and foreign residents.

D) the amount of a country's merchandise trade deficit or surplus.

Answer: C

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Conceptual

AACSB: Application of knowledge

4) Balance of payment (BOP) data may be important for any of the following reasons:

A) BOP data helps to forecast a country's market potential, especially in the short run.

B) The BOP is an important indicator of a country's foreign exchange rate.

C) Changes in a country's BOP may signal a change in controls over payment of dividends and

interest.

D) all of the choices provided above

Answer: D

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Conceptual

AACSB: Application of knowledge

5) A country experiencing a serious BOT ________ is more likely to ________ exports than

otherwise.

A) surplus; contract

B) surplus; expand

C) deficit; expand

D) none of the above

Answer: A

Diff: 2

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Analytical

AACSB: Analytical thinking

6) Which of the following would NOT be considered a typical BOP transaction?

A) Toyota U.S.A. is a U.S. distributor of automobiles manufactured in Japan by its parent

company.

B) The U.S. subsidiary of European financial giant, Credit Suisse, pays dividends to its parent in

Zurich.

C) A U.S. tourist purchases gifts at a museum in London.

D) All are examples of BOP transactions.

Answer: D

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Conceptual

AACSB: Application of knowledge

7) Which of the following is NOT an item to be considered in BOP calculations?

A) A foreign resident purchases a U.S. Treasury Bill.

B) A U.S.-based firm manages the development of an oil field in Kazakhstan.

C) A consumer buys a VCR made in Korea from a Florida Wal-Mart store.

D) A U.S. citizen living in Minnesota travels to Winnipeg, Canada, and buys a case of LaBatt's

Canadian beer.

Answer: C

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Conceptual

AACSB: Application of knowledge

8) The balance of payments:

A) determines the eligibility of countries for IMF aid.

B) adds up the value of all assets and liabilities of a country on a specific date.

C) records all international transactions for a country over a period of time.

D) all of the above

Answer: C

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

9) An American tourist purchases a leather jacket while in Italy. Which of the following

statements is true?

A) The leather purchase would be considered an import for the U.S. BOP.

B) This transaction would be properly accounted for in the Current Account of the U.S. BOP.

C) The leather purchase is considered an import of a good, and thus, considered part of the

balance of trade as well.

D) All of these statements are true.

Answer: D

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

10) Which of the following statements about the balance of payments is NOT true?

A) The BOP is the summary statement of all international transactions between one country and

all other countries.

B) The BOP is a flow statement, summarizing all international transactions that occur across the

geographic borders over a period of time, typically a year.

C) Although the BOP must always balance in theory, in practice there are substantial imbalances

as a result of statistical errors and misreporting of current account and financial account flows.

D) All of the above are true.

Answer: D

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

11) When the world went to a system of floating exchange rates, the Balance of Payments

became a relic of a system of fixed exchange rates and is no longer watched by serious economic

groups.

Answer: FALSE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Conceptual

AACSB: Application of knowledge

12) The BOP should always balance.

Answer: FALSE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

13) Changes in the BOP may predict the imposition or removal of foreign exchange controls.

Answer: TRUE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Conceptual

AACSB: Application of knowledge

14) A country experiencing a serious trade deficit is not as likely to expand imports as it would

be if running a surplus.

Answer: TRUE

Diff: 2

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Analytical

AACSB: Analytical thinking

15) The authors identify a tip for understanding BOP accounting. They recommend that you

"follow the cash flow."

Answer: TRUE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

16) The BOP must be in balance, but the current account need not be.

Answer: FALSE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

17) Expenditures by U.S. tourists in foreign countries for foreign goods or services are factored

into BOP calculations.

Answer: FALSE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

18) Like a balance sheet, the Balance of Payments adds up the value of all assets and liabilities

of a country on a specific date.

Answer: FALSE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

19) Because current and financial/capital account balances use double-entry bookkeeping it is

unusual to find serious discrepancies in the debits and credits.

Answer: FALSE

Diff: 1

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Recognition

AACSB: Application of knowledge

20) The measurement of all international economic transactions that take place between the

residents of a country and foreign residents is called the balance of payments (BOP). List and

explain three reasons why host-country BOP data is important to managers and investors.

Answer: BOP data is also important for the following reasons: 1) The BOP is an important

indicator of pressure on a country's foreign exchange rate, and thus of the potential for a firm

trading with or investing in that country to experience foreign exchange gains or losses. Changes

in the BOP may predict the imposition or removal of foreign exchange controls. 2) Changes in a

country's BOP may signal the imposition or removal of controls over payment of dividends and

interest, license fees, royalty fees, or other cash disbursements to foreign firms or investors. 3)

The BOP helps to forecast a country's market potential, especially in the short run. A country

experiencing a serious trade deficit is not as likely to expand imports as it would be if running a

surplus. It may, however, welcome investments that increase its exports.

Diff: 2

L.O.: 3.1 Fundamentals of BOP Accounting

Skill: Conceptual

AACSB: Application of knowledge

3.2 The Accounts of the Balance of Payments

1) Which of the following is NOT a part of the Current Account of BOP?

A) net export/import of goods

B) balance of trade

C) net portfolio investment

D) net export/import of services

Answer: C

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT part of the Financial Account of the BOP?

A) net foreign direct investment

B) net import/export of services

C) net portfolio investment

D) other Financial items

Answer: B

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

3) Which of the following is NOT part of the balance of payments account?

A) the current account

B) the financial/capital account

C) the official reserves account

D) All of the above are BOP accounts.

Answer: D

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

4) The ________ includes all international economic transactions with income or payment flows

occurring within the year.

A) capital account

B) current account

C) financial account

D) IMF account

Answer: B

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

5) If your company were to import and export textiles, the transactions would be recorded in the

current account subcategory of:

A) services trade.

B) income trade.

C) goods trade.

D) current transfers.

Answer: C

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

6) The travel services provided to international travelers by United Airlines would be recorded in

the current account subcategory of:

A) services trade.

B) income trade.

C) goods trade.

D) current transfers.

Answer: A

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

7) Anaconda Copper Inc. created a subsidiary in Chile last year to mine copper ore. The

proportion of net income paid back to the parent company as a dividend would be recorded in the

current account subcategory of:

A) services trade.

B) income trade.

C) goods trade.

D) current transfers.

Answer: B

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

8) The subcategory that typically dominates the current account is:

A) goods (merchandise) trade.

B) services trade.

C) income trade.

D) transfer accounts.

Answer: A

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

9) In 2016 the United States posted a current account deficit. The bulk of the negative value

came from:

A) a net transfer deficit.

B) an income balance deficit.

C) a goods trade deficit.

D) an income trade deficit.

Answer: C

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

10) Over the last two decades the surplus on U.S. services trade has typically been ________ the

deficit on U.S. goods trade.

A) greater than

B) equal to

C) less than

D) The relationship is constantly shifting from greater than to less than.

Answer: C

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

11) The ________ of the balance of payments measures all international economic transactions

of financial assets.

A) current account

B) merchandise trade account

C) services account

D) capital and financial accounts

Answer: D

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

12) The financial account consists COMPLETELY of which four components?

A) stock investment, bond investment, derivative investment, and mutual fund investment

B) direct investment, stock investment, net financial derivatives, and bond investment

C) direct investment, portfolio investment, net financial derivatives, and other asset investment

D) mutual fund investment, portfolio investment, derivative investment, and stock investment

Answer: C

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

13) When categorizing investments for the financial account component of the balance of

payments the ________ is an investment where the investor has no control whereas the

________ is an investment where the investor has control over the asset.

A) direct investment; portfolio investment

B) direct investment; indirect investment

C) portfolio investment; indirect investment

D) portfolio investment; direct investment

Answer: D

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

14) In general, there is consensus that ________ should be free, but there is no such consensus

that ________ should be free.

A) international investment; international goods trade

B) international investment; international trade

C) international trade; international goods trade

D) international trade; international investment

Answer: D

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

15) The two major concerns about foreign direct investment are:

A) national defense and taxes.

B) who controls the assets and who receives the profits.

C) who receives the profits and taxes.

D) who pays the taxes and who receives the taxes.

Answer: B

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

16) Portfolio investment is capital invested in activities that are ________ rather than made for

________.

A) short term; the long term

B) long term; profit

C) profit motivated; control

D) control motivated; profit

Answer: C

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

17) Consider the following: A foreign automobile company builds a manufacturing plant in

Tennessee and European investors buy U.S. Treasury Bonds.

A) Both activities would be considered direct investment.

B) Both activities would be considered portfolio investment.

C) The auto manufacturer in engaging in portfolio investment, and the European investors are

engaged in direct investing.

D) The auto manufacturer in engaging in direct investment, and the European investors are

engaged in portfolio investing.

Answer: D

Diff: 2

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

18) China is currently experiencing a surplus in its current account and its capital/financial

accounts. Which of the following is NOT a contributing factor for this unusual situation?

A) The exceptional growth in the Chinese economy contributes to the current account surplus.

B) The positive prospects for China's continued growth contribute to the capital/financial

account surplus.

C) China's inevitable acquisition of Taiwan is driving the market for Chinese investment.

D) All of the above are contributing factors for China's twin surpluses.

Answer: C

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

19) If China wished to reduce their accumulation of foreign exchange reserves they could:

A) allow their currency, the yuan, to float freely in the market place.

B) reduce their current account surplus by importing more goods than they export.

C) undertake both of the activities identified in choices A and B.

D) dig a big hole and bury the reserves.

Answer: C

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

20) The largest single component of the United States current account is:

A) current transfers.

B) income payments and receipts.

C) goods (merchandise) imports and exports.

D) services imports and exports.

Answer: C

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

21) In general, as a country's income increases, so does the demand for imports.

Answer: TRUE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

22) For at least the last decade, the United States has consistently run a surplus in services trade

income.

Answer: TRUE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

23) Expenditures by U.S. students abroad and foreign students pursuing studies in the United

States would be considered a services trade and part of the U.S. current account.

Answer: TRUE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

24) International debt security purchases and sales are defined as portfolio investments for

financial account purposes because by definition debt securities do not provide the buyer with

ownership or control.

Answer: TRUE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

25) Significant amounts of United States Treasury issues are purchased by foreign investors;

therefore, the U.S. must earn foreign currency to repay this debt.

Answer: FALSE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

26) In the United States and most developed countries, the current account and the combined

financial/capital accounts tend to be inversely related in that when one is positive, the other tends

to be negative.

Answer: TRUE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

27) The biggest problem that China faces in maintaining a stable value for their currency, the

yuan, is their lack of foreign exchange reserves.

Answer: FALSE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

28) As of year-end 2016, the United States still held the world's largest foreign exchange reserve,

but the total was rapidly being approached by China.

Answer: FALSE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

29) China's current political plan includes reducing their foreign exchange reserve balance by

allowing the yuan to float freely and by switching their goods balance from one of a net surplus

to a net deficit.

Answer: FALSE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Recognition

AACSB: Application of knowledge

30) An excess of merchandise exports over merchandise imports results in a balance of trade

deficit.

Answer: FALSE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

31) The transition to floating exchange rate regimes in the 1970s (described in Chapter .3)

changed the focus from the total BOP to its various subaccount like the current and financial

account balances.

Answer: TRUE

Diff: 1

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

32) What is a country's balance of (merchandise) trade, and why is it so widely reported in the

financial and popular press?

Answer: The balance of trade (BOT) is the largest and most important subset of a country's

current account. It measures the difference in a country's imports and exports over a specified

time period. It is often reported because it is intuitively easy to understand (i.e., we either sell

more or buy more from foreign countries) and it is a reasonable representation of the total current

account balance. (For example, for the U.S. the BOT was -$343B in 1999 while the current

account balance was -$807B in 2017.

Diff: 3

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

33) What is the Official Reserves Account (ORA), and why is it more important for countries

under a fixed exchange rate regime than for ones under a floating exchange rate regime?

Answer: The ORA is the total reserves held by official monetary authorities within the country.

Under a fixed exchange regime, a country's currency is convertible into a fixed amount of

another country's currency. To keep the relationship between currencies at equilibrium, it may

become necessary for the government to buy or sell official reserves until the equilibrium is

restored. Under a variable rate regime this is not necessary as exchange rates are allowed to

change and official reserves no longer serve the same purpose as under the fixed rate regime.

Diff: 3

L.O.: 3.2 The Accounts of the Balance of Payments

Skill: Conceptual

AACSB: Application of knowledge

3.3 The BOP Impacts on Key Macroeconomic Rates

1) Under an international regime of fixed exchange rates, countries with a BOP ________ should

consider ________ their currency while countries with a BOP ________ should consider

________ their currency.

A) deficit, revaluing; surplus, revaluing

B) deficit, devaluing; surplus, devaluing

C) surplus, devaluing; deficit, revaluing

D) surplus, revaluing; deficit, devaluing

Answer: D

Diff: 2

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Analytical

AACSB: Analytical thinking

2) Use the following terms for this question:

C = consumption

I = capital investment spending

G = government spending

X = exports of goods and services

M = imports of goods and services

BOP = balance of payments

GDP = gross domestic product

NPV = net present value

INF = inflation

R = real rate of return

The static equation for the nations GDP is:

A) GDP = C + I + G + (X + M ) × INF

B) GDP = C + I + G + X + M

C) GDP = C + I + G + X - M

D) GDP = C + I + X - M + R

Answer: C

Diff: 2

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Analytical

AACSB: Analytical thinking

3) Use the following terms for this question:

(X-M) = Current Account Balance

(CI-CO) = Capital Account Balance

(FI-FO) = Financial Account Balance

(I-S) = Investment-Saving Balance

FXB = Reserve Balance

BOP = balance of payments

GDP = gross domestic product

C = consumption

I = capital investment spending

G = government spending

The static equation for the BOP is:

A) BOP = (X-M) - (CI-CO) - (FI-FO) + FXB

B) BOP = (X-M) + (I-S) + (FI-FO) + FXB

C) BOP = (X-M) + (CI-CO) + (FI-FO) + FXB

D) BOP = GDP - [C + I +G] + (FI-FO)

Answer: C

Diff: 2

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Analytical

AACSB: Analytical thinking

4) Imports have the potential to lower a country's inflation rate because of each of the following

EXCEPT:

A) the import of lower priced goods limits what domestic competitors can charge for goods.

B) the import of lower priced services limits what domestic competitors can charge for services.

C) the higher prices of foreign goods spurs domestic competitors to cut prices.

D) all of the above

Answer: C

Diff: 2

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Recognition

AACSB: Application of knowledge

5) Under a fixed exchange rate system, the government bears the responsibility to ensure that the

BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the

government is expected to intervene in the foreign exchange market by buying or selling official

foreign exchange reserves. If the sum of the first two accounts is GREATER THAN ZERO, a

________ demand for the domestic currency exists in the world. To preserve the fixed exchange

rate, the government must then intervene in the foreign exchange market and ________ domestic

currency for foreign currencies or gold so as to bring the BOP back near zero.

A) surplus; sell

B) surplus; buy

C) deficit; sell

D) deficit; buy

Answer: A

Diff: 2

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Conceptual

AACSB: Application of knowledge

6) Under a fixed exchange rate system, the government bears the responsibility to ensure that the

BOP is near zero. If the sum of the current and capital accounts do not approximate zero, the

government is expected to intervene in the foreign exchange market by buying or selling official

foreign exchange reserves. If the sum of the first two accounts is LESS THAN ZERO, a

________ demand for the domestic currency exists in the world. To preserve the fixed exchange

rate, the government must then intervene in the foreign exchange market and ________ domestic

currency for foreign currencies or gold so as to bring the BOP back near zero.

A) surplus; sell

B) surplus; buy

C) deficit; sell

D) deficit; buy

Answer: D

Diff: 2

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Conceptual

AACSB: Application of knowledge

7) An increase in GDP should lead to a decrease in imports.

Answer: FALSE

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Recognition

AACSB: Application of knowledge

8) The effect of an imbalance in the BOP is the same for countries on a fixed exchange rate

regime as for those on a floating exchange rate regime.

Answer: FALSE

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Recognition

AACSB: Application of knowledge

9) Under a floating exchange rate system, the government bears the responsibility to ensure that

the BOP is near zero.

Answer: FALSE

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Recognition

AACSB: Application of knowledge

10) A country with a managed float that wishes to WEAKEN its currency may choose to raise

domestic interest rates to attract additional capital from abroad.

Answer: FALSE

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Conceptual

AACSB: Application of knowledge

11) A country's overall level of interest rates should have an impact on the financial account of

the BOP. Relatively low real interest rates should normally stimulate an outflow of capital

seeking higher interest rates in other country currencies.

Answer: TRUE

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Conceptual

AACSB: Application of knowledge

12) Imports have the potential to lower a country's inflation rate. In particular, imports of

HIGHER-priced goods and services place a limit on what domestic competitors charge for

comparable goods and services.

Answer: FALSE

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Recognition

AACSB: Application of knowledge

13) Very often governments seek to alter the market's valuation of their currency by influencing

relative interest rates, thus influencing the economic fundamentals of exchange rate

determination rather than through direct intervention in the foreign exchange markets. Describe

how this strategy works. Describe the case of the U.S. or China where the opposite effect, to the

suggest here, have occurred.

Answer: A country may choose to raise domestic interest rates to attract additional capital from

abroad (the short-term portfolio component of these capital flows). This step will alter market

forces and create additional market demand for the domestic currency in order to restore an

imbalance caused by the deficit in the current account. The process also raises the cost of local

borrowing for businesses so the policy is seldom without domestic negative consequences.

Relatively low real interest rates should normally stimulate an outflow of capital seeking higher

interest rates in other country currencies. However, in the case of the United States, the opposite

effect has occurred. Despite relatively low real interest rates and large BOP deficits on the

current account, the U.S. BOP financial account has experienced offsetting financial inflows due

to relatively attractive U.S. growth rate prospects, high levels of productive innovation, and

perceived political safety. Thus, the financial account inflows have helped the United States to

maintain its lower interest rates and to finance its exceptionally large fiscal deficit. However, it is

beginning to appear that the favorable inflow on the financial account is diminishing while the

U.S. balance on the current account is worsening.

Diff: 1

L.O.: 3.3 The BOP Impacts on Key Macroeconomic Rates

Skill: Conceptual

AACSB: Application of knowledge

3.4 Trade Balances and Exchange Rates

1) Of the following, which is NOT a part of J-Curve adjustment path?

A) the currency contract period

B) the exchange rate pass-through period

C) the quantity adjustment period

D) Each of the above is part of the J-Curve adjustment path.

Answer: D

Diff: 1

L.O.: 3.4 Trade Balances and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT likely to occur in the quantity adjustment phase of the J-Curve

adjustment path?

A) Imports become relatively more expensive.

B) Exports become relatively less expensive.

C) The balance of trade gets worse.

D) All of the above are true.

Answer: C

Diff: 2

L.O.: 3.4 Trade Balances and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

3) When a currency is devalued, the immediate impact may be an increase in a country's trade

deficit. However, this situation tends to correct itself in 2 to 5 weeks.

Answer: FALSE

Diff: 2

L.O.: 3.4 Trade Balances and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

4) The immediate impact of a devaluation of the domestic currency is to decrease the value of

the spot exchange rate S$/fc.

Answer: FALSE

Diff: 2

L.O.: 3.4 Trade Balances and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

5) Countries occasionally intentionally devalue their currencies. So what is the logic and likely

results of intentionally devaluing their domestic currency? International economic analysis

characterizes the trade balance adjustment process as occurring in three stages. List and explain

the three stages too.

Answer: International economic analysis characterizes the trade balance adjustment process as

occurring in three stages: 1) the currency contract period; 2) the pass-through period; and 3) the

quantity adjustment period. Assuming that the trade balance is already in deficit prior to the

devaluation, a devaluation at time results initially in a further deterioration in the trade balance

before an eventual improvement. The path of adjustment, as shown, takes on the shape of a

flattened "j."

In the currency contract period, a sudden unexpected devaluation of the domestic currency will

deteriorate the trade balance simply because all the contracts for exports and imports are already

in effect. Firms operating under these agreements are required to fulfill their obligations,

regardless of whether they profit or suffer losses. In the pass-through period, as exchange rates

change, importers and exporters eventually must pass these exchange rate changes through to

their own product prices. Import prices rise and export prices are now cheaper compared to

foreign competitors' because the dollar is cheaper. The third and final period, the quantity

adjustment period, achieves the balance of trade adjustment that is expected from a domestic

currency devaluation or depreciation. As the import and export prices change as a result of the

pass-through period, consumers both in the United States and in the U.S. export markets adjust

their demands to the new prices. Imports are relatively more expensive; therefore, the quantity

demanded decreases. Exports are relatively cheaper; therefore, the quantity demanded increases.

The balance of trade—the expenditures on exports less the expenditures on imports—improves.

Diff: 2

L.O.: 3.4 Trade Balances and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

3.5 Capital Mobility

1) The authors identify four distinct periods of capital mobility since 1860. Which do they term

as a "period of global economic destruction"?

A) 1860 - 1914

B) 1914 - 1945

C) 1945 - 1971

D) 1971 - 2007

Answer: B

Diff: 2

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

2) ________ is the cross-border purchase of assets that are then managed in a way that hides the

movement of money and its ownership.

A) Capital flight

B) Capital mobility

C) Irrational exuberance

D) Money laundering

Answer: D

Diff: 1

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

3) This was an era dominated by industrialized nation economies that were dependent on gold

convertibility to maintain confidence in the system.

A) The Gold Standard, 1860-1914

B) The Interwar Years, 1914-1945

C) The Bretton Woods Era, 1945-1971

D) The Floating Era, 1971-1997

Answer: A

Diff: 1

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

4) This dollar-based fixed exchange rate system gave rise to a long period of economic recovery

and growing openness of both international trade and capital flows in and out of more and more

countries.

A) The Gold Standard, 1860-1914

B) The Interwar Years , 1914-1945

C) The Bretton Woods Era, 1945-1971

D) The Floating Era, 1971-1997

Answer: C

Diff: 1

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

5) An era of retrenchment, in which major economic powers returned to policies of isolationism

and protectionism, restricting trade and nearly eliminating capital mobility.

A) The Gold Standard, 1860-1914

B) The Interwar Years , 1914-1945

C) The Bretton Woods Era, 1945-1971

D) The Floating Era, 1971-1997

Answer: B

Diff: 1

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

6) A ________ is any restriction that limits or alters the rate or direction of capital movement

into or out of a country.

A) capital budget

B) capital control

C) balance of trade deficit

D) balance of trade surplus

Answer: B

Diff: 1

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

7) Long-term capital flows reflect the following factors EXCEPT:

A) short-term interest rate differentials.

B) fundamental economic expectations.

C) growth prospects.

D) perceptions of political stability.

Answer: A

Diff: 1

L.O.: 3.5 Capital Mobility

Skill: Conceptual

AACSB: Application of knowledge

8) Capital controls may take a variety of forms EXCEPT:

A) currency boards.

B) taxes.

C) quotas.

D) prohibitions.

Answer: A

Diff: 1

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

9) The Bretton Woods era realized a great expansion of international trade in goods and services.

Answer: TRUE

Diff: 2

L.O.: 3.5 Capital Mobility

Skill: Recognition

AACSB: Application of knowledge

10) Longer-term capital flows reflect short-term interest rate differentials and exchange rate

expectations.

Answer: FALSE

Diff: 2

L.O.: 3.5 Capital Mobility

Skill: Conceptual

AACSB: Application of knowledge

11) One of the motivations for capital controls is to insulate an economy from foreign political

risks.

Answer: FALSE

Diff: 2

L.O.: 3.5 Capital Mobility

Skill: Conceptual

AACSB: Application of knowledge

12) Dutch Disease is a term applied to a problem in the 1970 whereby the Netherlands were

experiencing massive and sudden inflows of capital from abroad. What was the cause of this

sudden influx of capital, and what types of potential problems did it have for the Dutch or could

it have for any small single resource country?

Answer: With the rapid growth of the natural gas industry in the Netherlands in the 1970s, there

was growing fear that massive capital inflows would drive up the demand for the Dutch guilder

and cause a substantial currency appreciation. A more expensive guilder would then reduce the

international competitiveness of other Dutch manufacturing industries, causing their relative

decline to that of the natural resource industry. This is a challenge faced by a number of

resource-rich economies of relatively modest size and relatively small export sectors.

Diff: 2

L.O.: 3.5 Capital Mobility

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 4 Financial Goals and Corporate Governance

4.1 Business Ownership

1) Foreign stock markets are frequently characterized by controlling shareholders for the

individual publicly traded firms. Which of the following is NOT identified by the authors as

typical controlling shareholders?

A) the government (for example, privatized utilities)

B) institutions (such as banks in Germany)

C) family (such as in France)

D) All of the above were identified by the authors as controlling shareholders.

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT typically associated with the public ownership of business

organizations?

A) the state

B) the government

C) families

D) civil society

Answer: C

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

3) Which of the following is NOT typically associated with the private ownership of business

organizations?

A) the government

B) families

C) individuals

D) publicly traded, widely-held organizations

Answer: A

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

4) State Owned Enterprises (SOEs):

A) are a form of public ownership.

B) are created for commercial activities rather than civil or social activities.

C) are the dominant form of business organization in some countries.

D) are all of the above.

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

5) The problems that may arise due to the separation of ownership and management in large

business organizations are known as:

A) separation anxiety.

B) the agency problem.

C) corporate disconnect theory.

D) none of the above

Answer: B

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

6) Privatization is a term used to describe:

A) firms that are purchased by the government.

B) government operations that are purchased by corporations and other investors.

C) firms that do not use publicly available debt.

D) non-public meetings held by members of interlocking directorates.

Answer: B

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

7) "Maximize corporate wealth":

A) is the primary objective of the non-Anglo-American model of management.

B) as a management objective treats shareholders on a par with other corporate stakeholders such

as creditors, labor, and local community.

C) has a broader definition than just financial wealth.

D) all of the above

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

8) The Shareholder Wealth Maximization Model (SWM):

A) combines the interests and inputs of shareholders, creditors, management, employees, and

society.

B) is being usurped by the Stakeholder Capitalism Model as those types of MNEs dominate their

global industry segments.

C) clearly places shareholders as the primary stakeholder.

D) is the dominant form of corporate management in the European-Japanese governance system.

Answer: C

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

9) The Stakeholder Capitalism Model (SCM):

A) clearly places shareholders as the primary stakeholder.

B) combines the interests and inputs of shareholders, creditors, management, employees, and

society.

C) has financial profit as its goal and is often termed impatient capital.

D) is the Anglo-American model of corporate governance.

Answer: B

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

10) In the Anglo-American model of corporate governance, the primary goal of management is

to:

A) maximize the wealth of all stakeholders.

B) maximize shareholder wealth.

C) minimize costs.

D) minimize risk.

Answer: B

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

11) In finance, an efficient market is one in which:

A) prices are assumed to be correct.

B) prices adjust quickly and accurately to new information.

C) prices are the best allocators of capital in the macro economy.

D) all of the above

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

12) Systematic risk can be defined as:

A) the total risk to the firm.

B) the risk of the individual security.

C) the risk of the market in general.

D) the risk that can be systematically diversified away.

Answer: C

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

13) Unsystematic risk can be defined as:

A) the total risk to the firm.

B) the risk of the individual security.

C) the added risk that a firm's shares bring to a diversified portfolio.

D) the risk of the market in general.

Answer: B

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

14) The study of how shareholders can motivate management to accept the prescriptions of the

shareholder wealth maximization model is called:

A) market efficiency.

B) the SWM model.

C) agency theory.

D) the SCM model.

Answer: C

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

15) Under the Shareholder Wealth Maximization Model (SWM) of corporate governance, poor

firm performance is likely to be faced with all but which of the following?

A) sale of shares by disgruntled current shareholders

B) shareholder activism to attempt a change in current management

C) as a maximum threat, initiation of a corporate takeover

D) prison time for executive management

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

16) Which of the following is a reason why managers act to maximize shareholder wealth in

Anglo-American markets?

A) the use of stock options to align the goals of shareholders and managers

B) the market for corporate control that allows for outside takeover of the firm

C) performance-based compensation for executive management

D) all of the above

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

17) Which of the following is NOT true regarding the stakeholder capitalism model?

A) Banks and other financial institutions are less important creditors than securities markets.

B) Labor unions are more powerful than in the Anglo-American markets.

C) Governments interfere more in the marketplace to protect important stakeholder groups.

D) All of the above are TRUE.

Answer: A

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

18) The stakeholder capitalism model:

A) typically avoids the flaw of impatient capital.

B) tries to meet the desires of multiple stakeholders.

C) may leave management without a clear signal about tradeoffs among the several stakeholders.

D) all of the above

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

19) Which of the following is generally NOT considered to be a viable operational goal for a

firm?

A) maintaining a strong local currency

B) maximization of after-tax income

C) minimization of the firm's effective global tax burden

D) correct positioning of the firm's income, cash flows and available funds as to country and

currency

Answer: A

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

20) Which of the following operational goals for the international firm may be incompatible with

the others?

A) maintaining a strong local currency

B) maximization of after-tax income

C) minimization of the firm's effective global tax burden

D) Each of these goals may be incompatible with one or more of the others.

Answer: D

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

21) The primary operational goal for the firm is to:

A) maximize after-tax profits in each country where the firm is operating.

B) minimize the total financial risk to the firm.

C) maximize the consolidated after-tax profits of the firm.

D) maximize the total risk to the firm.

Answer: C

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

22) With shareholder wealth maximization as the manager's goal, capital may be termed:

A) impatient.

B) patient.

C) borrowed.

D) bought.

Answer: A

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

23) If share price rises from $12 to $15 per share, and pays a dividend of $1 per share, what was

the rate of return to shareholders?

A) 26.67%

B) -13.33%

C) 33.33%

D) 16.67%

Answer: C

Diff: 3

L.O.: 4.1 Business Ownership

Skill: Analytical

AACSB: Analytical thinking

24) PolyProduction Inc. has two classes of common stock. Class A has 5 million shares with 10

votes per share. Class B has 5 million shares with 1 vote per share. If the dividends per share are

equal for both class A and B stock, then Class A shareholders have ________ of the votes and

________ of the dividends.

A) 90.91%; 90.91%

B) 90.91%; 50.00%

C) 50.00%; 50.00%

D) 83.33%; 33.33%

Answer: B

Diff: 3

L.O.: 4.1 Business Ownership

Skill: Analytical

AACSB: Analytical thinking

25) In the U.S. and U.K. stock markets are characterized by ownership of firms concentrated in

the hands of a few controlling shareholders. In contrast, the rest of the world tends to have more

widespread ownership of shares.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

26) State Owned Enterprises (SOEs) by their very name cannot be traded on stock exchanges

because they are government owned.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

27) According to recent research, family-owned firms in some highly-developed economies

typically outperform publicly-owned firms.

Answer: TRUE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

28) According to the authors, dual classes of voting stock are the norm in non-Anglo-American

markets.

Answer: TRUE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

29) In recent years the trend has been for markets to increasing focus on the shareholder wealth

form of wealth maximization.

Answer: TRUE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

30) Non-Anglo-American markets are dominated by the "one-vote-one-share" rule.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

31) The stakeholder capitalism model (SCM) holds that total risk (operational and financial) is

more important than just systematic risk.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

32) In recent years the trend has been for markets to increasing focus on the global stakeholders.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

33) Patient Capitalism is characterized by short-term focus by both management and investors.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

34) Agency theory states that unsystematic risk can be eliminated through diversification.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

35) The stakeholder capitalism model does not assume that equity markets are either efficient or

inefficient.

Answer: TRUE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

36) The stakeholder capitalism model assumes that only systematic risk "counts" or is a prime

concern for management.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

37) Dividend yield is the change in the share price of stock as traded in the public equity

markets.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

38) The goal of all international corporations is to maximize shareholder wealth.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

39) Systematic risk can be eliminated through portfolio diversification.

Answer: FALSE

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

40) A recent study shows that privately held firms use less financial leverage and enjoy lower

costs of debt than publicly traded firms.

Answer: TRUE

Diff: 2

L.O.: 4.1 Business Ownership

Skill: Recognition

AACSB: Application of knowledge

41) In the stakeholder capitalism model (SCM) the assumption of market efficiency is absolutely

critical.

Answer: FALSE

Diff: 2

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

42) One of the most challenging issues in the financial management of the enterprise is the

possible separation of ownership from management resulting in the so-called principal agent

problem. Define the agency problem, explain possible ways to alleviate the agency problem and

discuss differences in across global markets.

Answer: The separation of ownership from management raises the possibility that the two

entities may have different business and financial objectives. This is the so-called principal agent

problem. There are several strategies for aligning shareholder and management interests, the

most common of which is for senior management to own shares or share options. What is then

good for the managers' own personal wealth is similar to that of general shareholders.

The United States and United Kingdom are two country markets characterized by wide-spread

ownership of shares. Management may own some small portion of stock in their firms, but

largely management is a hired agent that is expected to represent the interests of shareholders. In

contrast, many firms in many other global markets are characterized by controlling shareholders

such as government, institutions (e.g., banks in Germany), family (e.g., in France, Italy, and

throughout Asia and Latin America), and consortiums of interests (e.g., keiretsus in Japan and

chaebols in South Korea). A business that is owned and managed by the same entity does not

suffer the agency problem.

Diff: 1

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

43) Describe the management objectives of a firm governed by the shareholder wealth

maximization model and one governed by the stakeholder wealth maximization model. Give an

example of how these two models may lead to different decision-making by executive

management.

Answer: Shareholder wealth maximization attempts to do just that, typically through the

maximization of share price. Stakeholder wealth maximization is much more difficult because of

the necessity to satisfy many stakeholders all having approximately equal claim on the objectives

of management. These stakeholders may include shareholders, creditors, customers, employees,

and community. Differing decisions may occur in a situation that involves significant social

costs. For example, in the U.S. the decision to shift production from a local factory to a foreign

one may be in large based on the change in NPV as the result of the move with only minor

consideration of the impact that a change in location would have on the community at large or

the local employees. A manager of a stakeholder driven firm may place equal or greater

emphasis on the local employees and community and choose to maintain the current facility

rather than move even if the foreign operation provided a much greater NPV. Ultimately, the

latter may cause an inefficient allocation of scarce resources and lead to an overall lower

standard of living.

Diff: 3

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

44) Define patient and impatient capitalism and discuss how each may lead to different decision-

making in the shareholder wealth maximization model.

Answer: Patient capitalism may be defined as a focus on long-term shareholder wealth

maximization and is often associated with management focusing on long-term investments with

less emphasis placed on short-term or trendy objectives. On the other hand, impatient capitalism

could be described as a destructive focus on the short term by both management and investors.

These differences in the time horizon could lead to different and perhaps inferior decisions by

existing management and ultimately be costly to the shareholders.

Diff: 3

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

45) What are the most important distinctions that make state owned enterprises (SOEs) different

from other forms of government organizations?

Answer: State owned enterprises are created distinctly for the purpose of commercial activities,

rather than the multitude of other social, civil, and regulatory activities of government. SOEs are

today, in many countries, the dominant form of business entity.

Diff: 2

L.O.: 4.1 Business Ownership

Skill: Conceptual

AACSB: Application of knowledge

4.2 Publicly Traded versus Privately Held: The Global Shift

1) The number of publicly traded firms:

A) peaked in the U.S. in 1996.

B) peaked worldwide in 1996.

C) increased significantly in 2009 as a result of the international financial crisis.

D) all of the above

Answer: A

Diff: 1

L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT a source of new stock exchange listing additions?

A) initial public offerings

B) movements of share listings from one exchange to another

C) spinouts from larger firms

D) All of the above are sources.

Answer: D

Diff: 1

L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift

Skill: Recognition

AACSB: Application of knowledge

3) Which of the following is NOT a delisting category?

A) forced delistings

B) mergers

C) acquisitions

D) All of the above are categories of delistings.

Answer: D

Diff: 1

L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift

Skill: Recognition

AACSB: Application of knowledge

4) U.S. listings of publicly traded firms as a percentage of worldwide listings of such firms

INCREASED from 11% in 1996 to approximately 33% in 2015.

Answer: FALSE

Diff: 1

L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift

Skill: Recognition

AACSB: Application of knowledge

5) Companies that are delisted cease to trade.

Answer: FALSE

Diff: 1

L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift

Skill: Recognition

AACSB: Application of knowledge

6) Since movements between exchanges typically are a zero sum within a country, and spinouts

and bulletin board movements are few in number, real growth in listings comes from IPOs.

Answer: FALSE

Diff: 1

L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift

Skill: Recognition

AACSB: Application of knowledge

7) The decline of share listings in the United States has led to considerable debate over whether

these trends represent a fundamental global business shift away from the publicly traded

corporate form, or something that is more U.S.-centric combined with the economic times.

Develop an argument to why the decline happened.

Answer: One recent study argued that it was not really the increasingly burdensome U.S.

regulatory environment that was to blame, but rather a proliferation of factors that caused the

decline in market making, sales, and research support for small and medium-sized equities.

Beginning with the introduction of online brokerage in 1996 and online trading rules in 1997,

more and more equity trading in the United States shifted to electronic communication networks

which allowed all market participants to trade directly with the exchange order books, and not

through brokers or brokerage houses. Although this increased competition reduced transaction

costs dramatically, it also undermined the profitability of the retail brokerage houses, which had

always supported research, market making, and sales and promotion of the small- to medium-

sized equities. Without this financial support, the smaller stocks were no longer covered and

promoted by the major equity houses. Without that research, marketing, promotion and coverage,

their trading volumes and values fell.

Diff: 1

L.O.: 4.2 Publicly Traded versus Privately Held: The Global Shift

Skill: Conceptual

AACSB: Application of knowledge

4.3 Corporate Governance

1) Which of the following broad topics is NOT identified as an area to be established as good

corporate governance practice by the Organization for Economic Cooperation and Development

(OECD)?

A) protect the rights of shareholders

B) disclosure and transparency

C) the proper role of stakeholders in the governance of the firm

D) All of the above should be a concern of good corporate governance.

Answer: D

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

2) The relationship among stakeholders used to determine and control the strategic direction and

performance of an organization is termed:

A) corporate governance.

B) Anglo-American activism.

C) capital structure.

D) working capital management.

Answer: A

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

3) When discussing the structure of corporate governance, the authors distinguish between

internal and external factors. ________ is an example of an internal factor, and ________ is an

example of an external factor.

A) Equity markets; executive management

B) Debt markets; board of directors

C) Executive management; auditors

D) Auditors; regulators

Answer: C

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT commonly associated with a government affiliated form of

corporate governance regime?

A) no minority influence

B) lack of transparency

C) state ownership of enterprise

D) All are associated with this type of corporate governance regime.

Answer: D

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

5) Generally speaking, which of the following is NOT considered an important factor in the

composition and control of corporate boards of directors?

A) the number of insider vs. outside directors

B) the total number of directors on the board

C) the composition of the compensation committee

D) All of the above are important factors of board composition.

Answer: D

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

6) Signed into law on July 30, 2002, the ________ Act requires CEOs of publicly traded

companies to vouch for the veracity of the firm's published financial statements.

A) Smoot-Hawley

B) Humphrey-Hawkins

C) McCain-Merrill

D) Sarbanes-Oxley

Answer: D

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

7) The Sarbanes-Oxley Act, passed by the U.S. Congress in July 2002, was designed to:

A) reinstitute heavy tariffs on international trade.

B) reform corporate governance.

C) limit the Federal Reserve Board's ability to engage in the buying and selling of gold.

D) limit trade with countries deemed lenient on terrorism.

Answer: B

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

8) Anglo-American markets is a term used to describe business markets in:

A) North, Central, and South America.

B) the United States, Canada, and Western Europe.

C) the United States, United Kingdom, Canada, Australia and New Zealand.

D) the United States, France, Britain, and Germany.

Answer: C

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

9) The deliberation of the of the process demonstrated in the European-Japanese system of

corporate governance has sometimes been termed:

A) socialism.

B) impatient capital.

C) patient capital.

D) communism.

Answer: C

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Conceptual

AACSB: Application of knowledge

10) Which of the following is NOT an important concept when distinguishing between

international and domestic financial management?

A) corporate governance

B) culture, history, and institutions

C) political risk

D) All of the above are important distinguishing concepts.

Answer: D

Diff: 2

L.O.: 4.3 Corporate Governance

Skill: Conceptual

AACSB: Application of knowledge

11) The Board of Directors:

A) consists exclusively of the officers of the corporation.

B) is the legal body which is accountable for the governance of the corporation.

C) are not subject to the external forces of the marketplace.

D) is appointed by the Securities and Exchange Commission (SEC).

Answer: B

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

12) Which of the following is NOT a possible and appropriate response by shareholders

dissatisfied with existing firm management of a publicly traded firm?

A) Shareholders could sell their shares of stock.

B) Shareholders could remain quietly disgruntled.

C) Shareholders, perhaps with the help of others, could attempt to initiate a takeover.

D) All of these responses may be possible and appropriate.

Answer: D

Diff: 2

L.O.: 4.3 Corporate Governance

Skill: Conceptual

AACSB: Application of knowledge

13) Regarding comparative corporate governance regimes: Bank-based regimes characterized by

government influence in bank lending and a lack of transparency is often found in countries such

as Korea and Germany.

Answer: TRUE

Diff: 2

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

14) Investor protection is typically better in countries with codified civil law (the Code

Napoleon) than in countries with a legal system based in English common law.

Answer: FALSE

Diff: 2

L.O.: 4.3 Corporate Governance

Skill: Conceptual

AACSB: Application of knowledge

15) The relatively low cost of compliance with the Sarbanes-Oxley Act (SOX) has been a

surprising benefit of the act.

Answer: FALSE

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Recognition

AACSB: Application of knowledge

16) Having Anglo-Americans as members of the board of directors of a non-Anglo-American

firm signals poor corporate governance in the firm.

Answer: FALSE

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Conceptual

AACSB: Application of knowledge

17) Although there are many different cultural and legal approaches used in corporate

governance worldwide, there is a growing consensus on what constitutes good corporate

governance. List and explain at least three standardized common principles of good corporate

governance.

Answer: 1) A board of directors that has both internal and external members. More importantly,

it should be staffed by individuals of true experience and knowledge of not only their own rules

and responsibilities, but of the nature and conduct of the corporate business. 2) A management

compensation system that is aligned with corporate performance (financial and otherwise) and

has significant oversight from the board and open disclosure to shareholders and investors. 3)

Independent auditing of corporate financial results on a meaningful real-time basis. An audit

process with oversight by a Board committee composed primarily of external members would be

an additional significant improvement. 4) Timely public reporting of both financial and

nonfinancial operating results that may be used by investors to assess the investment outlook.

This should also include transparency and reporting around potentially significant liabilities.

Diff: 1

L.O.: 4.3 Corporate Governance

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 5 The Foreign Exchange Market

5.1 Functions of the Foreign Exchange Market

1) Which of the following is NOT true regarding the market for foreign exchange?

A) The market provides the physical and institutional structure through which the money of one

country is exchanged for another.

B) The rate of exchange is determined in the market.

C) Foreign exchange transactions are physically completed in the foreign exchange market.

D) All of the above are true.

Answer: D

Diff: 1

L.O.: 5.1 Functions of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

2) A/An ________ is an agreement between a buyer and seller that a fixed amount of one

currency will be delivered at a specified rate for some other currency.

A) Eurodollar transaction

B) import/export exchange

C) foreign exchange transaction

D) interbank market transaction

Answer: C

Diff: 1

L.O.: 5.1 Functions of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

3) The ________ is the mechanism by which participants transfer purchasing power between

countries, obtain or provide credit for international trade transactions, and minimize exposure to

the risks of exchange rate changes.

A) futures market

B) federal open market

C) foreign exchange market

D) LIBOR

Answer: C

Diff: 1

L.O.: 5.1 Functions of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT a motivation identified by the authors as a function of the

foreign exchange market?

A) the transfer of purchasing power between countries

B) obtaining or providing credit for international trade transactions

C) minimizing the risks of exchange rate changes

D) All of the above were identified as functions of the foreign exchange market.

Answer: D

Diff: 1

L.O.: 5.1 Functions of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

5) Business firms in countries with exchange controls, for example, China (mainland), often

must surrender foreign exchange earned from exports to the central bank at the daily fixing price.

Answer: TRUE

Diff: 1

L.O.: 5.1 Functions of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

6) The foreign exchange market provides the physical and institutional structure through which

three typical functions are accomplish. List and explain three functions of the foreign exchange

market.

Answer: The foreign exchange market is the mechanism by which participants transfer

purchasing power between countries by exchanging money, obtain or provide credit for

international trade transactions, and minimize exposure to the risks of exchange rate changes.

1) The transfer of purchasing power is necessary because international trade and capital

transactions normally involve parties living in countries with different national currencies.

Usually each party wants to deal in its own currency, but the trade or capital transaction can be

invoiced in only one currency. Hence, one party must deal in a foreign currency. 2) Because the

movement of goods between countries takes time, inventory in transit must be financed. The

foreign exchange market provides a source of credit. Specialized instruments, such as bankers'

acceptances and letters of credit are available to finance international trade. 3) The foreign

exchange market provides "hedging" facilities for transferring foreign exchange risk to someone

else more willing to carry risk.

Diff: 1

L.O.: 5.1 Functions of the Foreign Exchange Market

Skill: Conceptual

AACSB: Application of knowledge

5.2 Structure of the Foreign Exchange Market

1) While trading in foreign exchange takes place worldwide, the major currency trading centers

are located in:

A) London, New York, and Tokyo.

B) New York, Zurich, and Bahrain.

C) Paris, Frankfurt, and London.

D) Los Angeles, New York, and London.

Answer: A

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

2) The authors identify two tiers of foreign exchange markets:

A) bank and nonbank foreign exchange.

B) commercial and investment transactions.

C) interbank and client markets.

D) client and retail market.

Answer: C

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

3) It is characteristic of foreign exchange dealers to:

A) bring buyers and sellers of currencies together but never to buy and hold an inventory of

currency for resale.

B) act as market makers, willing to buy and sell the currencies in which they specialize.

C) trade only with clients in the retail market and never operate in the wholesale market for

foreign exchange.

D) All of the above are characteristics of foreign exchange dealers.

Answer: B

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following may be participants in the foreign exchange markets?

A) bank and nonbank foreign exchange dealers

B) central banks and treasuries

C) speculators and arbitrageurs

D) all of the above

Answer: D

Diff: 1

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

5) ________ seek to profit from trading in the market itself rather than having the foreign

exchange transaction being incidental to the execution of a commercial or investment

transaction.

A) Speculators and arbitrageurs

B) Foreign exchange brokers

C) Central banks

D) Treasuries

Answer: A

Diff: 1

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

6) In the foreign exchange market, ________ seek all of their profit from exchange rate changes

while ________ seek to profit from simultaneous exchange rate differences in different markets.

A) wholesalers; retailers

B) central banks; treasuries

C) speculators; arbitrageurs

D) dealers; brokers

Answer: C

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

7) Foreign exchange ________ earn a profit by a bid-ask spread on currencies they purchase and

sell. Foreign exchange ________, on the other hand, earn a profit by bringing together buyers

and sellers of foreign currencies and earning a commission on each sale and purchase.

A) central banks; treasuries

B) dealers; brokers

C) brokers; dealers

D) speculators; arbitrageurs

Answer: B

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

8) ________ are agents who facilitate trading between dealers without themselves becoming

principals in the transaction.

A) Central banks

B) Foreign exchange brokers

C) Arbitrageurs

D) Foreign exchange dealers

Answer: B

Diff: 1

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

9) Because the market for foreign exchange is worldwide, the volume of foreign exchange

currency transactions is level throughout the 24-hour day.

Answer: FALSE

Diff: 1

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

10) Foreign exchange markets are a relatively recent phenomenon, beginning with the agreement

at Bretton Woods.

Answer: FALSE

Diff: 1

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Conceptual

AACSB: Application of knowledge

11) Dealers in foreign exchange departments at large international banks act as market makers

and maintain inventories of the securities in which they specialize.

Answer: TRUE

Diff: 1

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

12) Currency trading lacks profitability for large commercial and investment banks but is

maintained as a service for corporate and institutional customers.

Answer: FALSE

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

13) The primary motive of foreign exchange activities by most central banks is profit.

Answer: FALSE

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

14) Banks, and a few nonbank foreign exchange dealers, operate ONLY in the interbank

markets.

Answer: FALSE

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

15) Dealers in the foreign exchange departments of large international banks often function as

"market makers." Such dealers stand willing at all times to buy and sell those currencies in which

they specialize and thus maintain an "inventory" position in those currencies.

Answer: TRUE

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

16) Currency trading is a service center rather than a profit center for commercial and investment

banks.

Answer: FALSE

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

17) For individuals and firms involved in the import and export of goods and services, using the

foreign exchange market is necessary, but incidental, to their underlying commercial or

investment purpose.

Answer: TRUE

Diff: 2

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

18) Most transactions in the interbank foreign exchange trading are primarily conducted via

telecommunication techniques and little is conducted face-to-face.

Answer: TRUE

Diff: 1

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

19) What are some of the reasons central banks and treasuries enter the foreign exchange

markets, and in what important ways are they different from other foreign exchange participants?

Answer: Central banks and treasuries enter the foreign exchange market to acquire/spend their

own foreign exchange reserves and to influence the price at which their own currency is traded.

Unlike other market participants, they are not profit oriented. Instead, they may willingly take a

loss if they think it is in their best national interest.

Diff: 3

L.O.: 5.2 Structure of the Foreign Exchange Market

Skill: Conceptual

AACSB: Application of knowledge

5.3 Transactions in the Foreign Exchange Market

1) ________ is NOT one of the three categories reported for foreign exchange.

A) Spot transactions

B) Swap transactions

C) Strip transactions

D) Futures transactions

Answer: C

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

2) A ________ transaction in the foreign exchange market requires an almost immediate delivery

(typically within two days) of foreign exchange.

A) spot

B) forward

C) futures

D) none of the above

Answer: A

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

3) A ________ transaction in the foreign exchange market requires delivery of foreign exchange

at some future date.

A) spot

B) forward

C) swap

D) currency

Answer: B

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

4) A forward contract to deliver British pounds for U.S. dollars could be described either as

________ or ________.

A) buying dollars forward; buying pounds forward

B) selling pounds forward; selling dollars forward

C) selling pounds forward; buying dollars forward

D) selling dollars forward; buying pounds forward

Answer: C

Diff: 2

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Conceptual

AACSB: Application of knowledge

5) A common type of swap transaction in the foreign exchange market is the ________ where

the dealer buys the currency in the spot market and sells the same amount back to the same bank

in the forward market.

A) "forward against spot"

B) "forspot"

C) "repurchase agreement"

D) "spot against forward"

Answer: D

Diff: 2

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

6) The ________ is a derivative forward contract that was created in the 1990s. It has the same

characteristics and documentation requirements as traditional forward contracts except that they

are only settled in U.S. dollars and the foreign currency involved in the transaction is not

delivered.

A) nondeliverable forward

B) dollar only forward

C) virtual forward

D) internet forward

Answer: A

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

7) Which of the following is NOT true regarding nondeliverable forward (NDF) contracts?

A) NDFs are used primarily for emerging market currencies.

B) Pricing of NDFs reflects basic interest rate differentials plus an additional premium charged

for dollar settlement.

C) NDFs can only be traded by central banks.

D) All of the above are true.

Answer: C

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Conceptual

AACSB: Application of knowledge

8) A ________ transaction in the interbank market is the simultaneous purchase and sale of a

given amount of foreign exchange for two different value dates.

A) spot

B) forward-forward

C) swap

D) futures

Answer: C

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

9) Daily trading volume in the foreign exchange market was about ________ per ________ in

2015.

A) $5,100 billion; month

B) $3,100 billion; month

C) $5,100 billion; day

D) $3,100 billion; day

Answer: C

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

10) The greatest volume of daily foreign exchange transactions are:

A) spot transactions.

B) forward transactions.

C) swap transactions.

D) This question is inappropriate because the volume of transactions are approximately equal

across the three categories above.

Answer: C

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

11) The United Kingdom and United States together make up nearly ________ of daily currency

trading.

A) 30%

B) 40%

C) 50%

D) 60%

Answer: D

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

12) The top three currency pairs traded with the U.S. dollar are:

A) U.K. pound, Chinese Yuan, Japanese yen.

B) Swiss franc, euro, Japanese yen.

C) U.K. pound, euro, Japanese yen.

D) euro, Chinese Yuan, Japanese yen.

Answer: C

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

13) The greatest amount of foreign exchange trading takes place in the following three cities:

A) New York, London, and Tokyo.

B) New York, Singapore, and London.

C) London, Frankfurt, and Paris.

D) London, Tokyo, and Zurich.

Answer: B

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

14) The four currencies that constitute about 80% of all foreign exchange trading are:

A) U.K pound, Chinese yuan, euro, and Japanese yen.

B) U.S. dollar, euro, Chinese yuan, and U.K. pound.

C) U.S. dollar, Japanese yen, euro, and U.K. pound.

D) U.S. dollar, U.K. pound, yen, and Chinese yuan.

Answer: C

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

15) A spot transaction in the interbank market for foreign exchange would typically involve a

two-day delay in the actual delivery of the currencies, while such a transaction between a bank

and its commercial customer would not necessarily involve a two-day wait.

Answer: TRUE

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

16) Nondeliverable Forwards were originally envisioned as a method of currency speculation,

but it is now estimated that 70% of NDFs are trading for hedging purposes.

Answer: FALSE

Diff: 2

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

17) In general, NDF markets normally develop for country currencies having large cross-border

capital movements, but still subject to convertibility restrictions.

Answer: TRUE

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Conceptual

AACSB: Application of knowledge

18) NDFs are traded and settled inside the country of the subject currency, and therefore are

within the control of the country's government.

Answer: FALSE

Diff: 2

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

19) A contract to deliver dollars for euros in six months is both "buying euros forward for

dollars" and "selling dollars forward for euros."

Answer: TRUE

Diff: 2

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

20) As you might expect, the foreign exchange daily trading volume in in New York City is

roughly twice as large as the daily trading volume in London.

Answer: FALSE

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

21) The low level of interest rates around the globe in recent years, combined with slowing

economic growth and new debt issuances, has had a dampening impact on the swap market.

Answer: FALSE

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

22) Since the global financial crisis of 2008-2009, the Chinese renminbi (yuan) has become the

most widely traded currency with the U.S. dollar surpassing the euro, yen, and pound as dollar

trading pairs.

Answer: FALSE

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

23) Swap and forward transactions account for an insignificant portion of the foreign exchange

market.

Answer: FALSE

Diff: 1

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Recognition

AACSB: Application of knowledge

24) Define spot, forward, and swap transactions in the foreign exchange market and give an

example of how each could be used.

Answer: Spot transactions are exchanging one currency for another right now. Spot transactions

are typically entered into because the parties need to exchange foreign currencies that they have

received into their domestic currency, or because they have an obligation that requires them to

obtain foreign currency.

Forward foreign exchange transactions are agreements entered into today to exchange currencies

at a particular price at some point in the future. Forwards may be speculative or a hedge against

unexpected changes in the price of the other currency.

Swaps are the simultaneous purchase and sale of a given amount of a foreign exchange for two

different dates. Both transactions are conducted with the same counterparty. A swap may be

considered a technique for borrowing another currency on a fully collateralized basis.

Diff: 2

L.O.: 5.3 Transactions in the Foreign Exchange Market

Skill: Conceptual

AACSB: Application of knowledge

5.4 Foreign Exchange Rates and Quotations

1) A foreign exchange ________ is the price of one currency expressed in terms of another

currency. A foreign exchange ________ is a willingness to buy or sell at the announced rate.

A) quote; rate

B) quote; quote

C) rate; quote

D) rate; rate

Answer: C

Diff: 1

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

2) Most foreign exchange transactions are through the U.S. dollar. If the transaction is expressed

as the foreign currency per dollar this known as ________ whereas ________ are expressed as

dollars per foreign unit.

A) European terms; indirect

B) American terms; direct

C) American terms; European terms

D) European terms; American terms

Answer: D

Diff: 1

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

3) The following is an example of an American term foreign exchange quote:

A) $20/£

B) €0.85/$

C) ¥100/€

D) none of the above

Answer: A

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

4) From the viewpoint of a British investor, which of the following would be a direct quote in the

foreign exchange market?

A) SF2.40/£

B) $1.50/£

C) £0.55/€

D) $0.90/€

Answer: C

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

5) A/an ________ quote in the United States would be foreign units per dollar, while a/an

________ quote would be in dollars per foreign currency unit.

A) direct; direct

B) direct; indirect

C) indirect; indirect

D) indirect; direct

Answer: D

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Recognition

AACSB: Application of knowledge

6) If the direct quote for a U.S. investor for British pounds is $1.43/£, then the indirect quote for

the U.S. investor would be ________ and the direct quote for the British investor would be

________.

A) £0.699/$; £0.699/$

B) $0.699/£; £0.699/$

C) £1.43/£; £0.699/$

D) £0.699/$; $1.43/£

Answer: A

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

7) ________ make money on currency exchanges by the difference between the ________ price,

or the price they offer to pay, and the ________ price, or the price at which they offer to sell the

currency.

A) Dealers; ask; bid

B) Dealers; bid; ask

C) Brokers; ask; bid

D) Brokers; bid; ask

Answer: B

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

TABLE 5.1

Use the table to answer following question(s).

8) Refer to Table 5.1. The current spot rate of dollars per pound as quoted in a newspaper is

________ or ________.

A) £1.4484/$; $0.6904/£

B) $1.4481/£; £0.6906/$

C) $1.4484/£; £0.6904/$

D) £1.4487/$; $0.6903/£

Answer: C

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

9) Refer to Table 5.1. The one-month forward bid price for dollars as denominated in Japanese

yen is:

A) -¥20.

B) -¥18.

C) ¥129.74/$.

D) ¥129.62/$.

Answer: D

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

10) Refer to Table 5.1. The ask price for the two-year swap for a British pound is:

A) $1.4250/£.

B) $1.4257/£.

C) -$230.

D) -$238.

Answer: B

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

11) Refer to Table 5.1. According to the information provided in the table, the 6-month yen is

selling at a forward ________ of approximately ________ per annum. (Use the mid rates to

make your calculations.)

A) discount; 2.09%

B) discount; 2.06%

C) premium; 2.09%

D) premium; 2.06%

Answer: C

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

12) Given the following exchange rates, which of the multiple-choice choices represents a

potentially profitable intermarket arbitrage opportunity?

¥129.87/$

€1.1226/$

€0.00864/¥

A) ¥115.69/€

B) ¥114.96/€

C) $0.8908/€

D) $0.0077/¥

Answer: B

Diff: 3

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

13) The U.S. dollar suddenly changes in value against the euro moving from an exchange rate of

0.8909/€ to $0.8709/€. Thus, the dollar has ________ by ________.

A) appreciated; 2.30%

B) depreciated; 2.30%

C) appreciated; 2.24%

D) depreciated; 2.24%

Answer: A

Diff: 3

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

14) A German firm is attempting to determine the euro/pound exchange rate and has the

following exchange rate information: USD/pound = $1.5509/£ and the USD/euro rate =

$1.2194/€. Therefore, the euro/pound rate must be:

A) £1.2719/€.

B) €1.2719/£.

C) €0.7316/£.

D) €0.7863/£.

Answer: B

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Analytical

AACSB: Analytical thinking

15) The European and American terms for foreign currency exchange are square roots of one

another.

Answer: FALSE

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Recognition

AACSB: Application of knowledge

16) When the cross rate for currencies offered by two banks differs from the exchange rate

offered by a third bank, a triangular arbitrage opportunity exists.

Answer: TRUE

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Recognition

AACSB: Application of knowledge

17) A confusing "quirk" of international exchange rates occurs when calculating the percentage

change in spot rates from one period to another. The percent change in the spot rate from one

period to another when quoted using foreign currency terms is always greater than the percent

changes quoted when using home currency terms.

Answer: FALSE

Diff: 1

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

18) The most commonly quoted currency exchange is that between the U.S. dollar and the

European euro. For example, a quotation of EUR/USD 1.2174. The euro is the base currency and

the dollar the price currency.

Answer: TRUE

Diff: 1

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Recognition

AACSB: Application of knowledge

19) Since in the U.S. the home currency is the dollar and the foreign currency is the euro, in New

York USD 1.2174 = EUR 1.00 would be a direct quote on the euro and an indirect quote on the

dollar.

Answer: TRUE

Diff: 1

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

20) A bid is the price in one currency at which a dealer will buy another currency. An ask is the

price at which a dealer will sell the other currency. Dealers bid (buy) at one price and ask (sell) at

a slightly higher price, making their profit from the spread between the prices. List and explain

three reasons/factors that could make the spread small.

Answer: The bid-ask spread may be quite large for currencies that are traded infrequently, in

small volumes, or both. The spread in wholesale transactions between banks and large

corporations is normally smaller than in the retail market. Competition among dealers worldwide

narrows the spread between bids and offers and so contributes to making the foreign exchange

market "efficient" in the same sense as are securities markets. Other factors that affect the spread

are the cost of processing orders, the cost of maintaining an inventory of a particular currency,

and the volatility in the value of a currency.

Diff: 2

L.O.: 5.4 Foreign Exchange Rates and Quotations

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 6 International Parity Conditions

6.1 Prices and Exchange Rates

1) If an identical product can be sold in two different markets, and no restrictions exist on the

sale or transportation of product between markets, the product's price should be the same in both

markets. This is known as:

A) relative purchasing power parity.

B) interest rate parity.

C) the law of one price.

D) equilibrium.

Answer: C

Diff: 1

L.O.: 6.1 Prices and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

2) The Economist publishes annually the "Big Mac Index" by which they compare the prices of

the McDonald's Corporation's Big Mac hamburger around the world. The index estimates the

exchange rates for currencies based on the assumption that the burgers in question are the same

across the world and therefore, the price should be the same. If a Big Mac costs $2.54 in the

United States and 294 yen in Japan, what is the estimated exchange rate of yen per dollar as

hypothesized by the Hamburger index?

A) $0.0086/¥

B) ¥124/$

C) $0.0081/¥

D) ¥115.75/$

Answer: D

Diff: 3

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

3) If the current exchange rate is 113 Japanese yen per U.S. dollar, the price of a Big Mac

hamburger in the United States is $3.41, and the price of a Big Mac hamburger in Japan is 280

yen, then other things equal, the Big Mac hamburger in Japan is:

A) correctly priced.

B) under priced.

C) over priced.

D) There is not enough information to determine if the price is appropriate or not.

Answer: B

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

4) The price of a Big Mac in the U.S. is $3.41 and the price in Mexico is Peso 29.0. What is the

implied PPP of the Peso per dollar?

A) Peso 8.50/$1

B) Peso 10.8/$1

C) Peso 11.76/$1

D) None of the above

Answer: A

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

5) Assume the implied PPP rate of exchange of Mexican Pesos per U.S. dollar is 8.50 according

to the Big Mac Index. Further, assume the current exchange rate is Peso 10.80/$1. Thus,

according to PPP and the Law of One Price, at the current exchange rate the peso is:

A) overvalued.

B) undervalued.

C) correctly valued.

D) There is not enough information to answer this question.

Answer: B

Diff: 3

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

6) According to the Big Mac Index, the implied PPP exchange rate is Mexican peso 8.50/$1 but

the actual exchange rate is peso 10.80/$1. Thus, at current exchange rates the peso appears to be

________ by ________.

A) overvalued; approximately 21%

B) overvalued; approximately 27%

C) undervalued; approximately 21%

D) undervalued; approximately 27%

Answer: C

Diff: 3

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

7) Other things equal, and assuming efficient markets, if a Honda Accord costs $24,682 in the

U.S., then at an exchange rate of $1.57/£, the Honda Accord should cost ________ in Great

Britain.

A) £24,682

B) £38,751

C) £10,795

D) £15,721

Answer: D

Diff: 1

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

8) One year ago the spot rate of U.S. dollars for Canadian dollars was $1/C$1. Since that time

the rate of inflation in the U.S. has been 4% greater than that in Canada. Based on the theory of

Relative PPP, the current spot exchange rate of U.S. dollars for Canadian dollars should be

approximately:

A) $0.96/C$.

B) $1/C$.

C) $1.04/C$.

D) Relative PPP provides no guide for this type of question.

Answer: C

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

9) ________ states that differential rates of inflation between two countries tend to be offset over

time by an equal but opposite change in the spot exchange rate.

A) The Fisher Effect

B) The International Fisher Effect

C) Absolute Purchasing Power Parity

D) Relative Purchasing Power Parity

Answer: D

Diff: 1

L.O.: 6.1 Prices and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

10) Two general conclusions can be made from the empirical tests of purchasing power parity

(PPP):

A) PPP holds up well over the short run but poorly for the long run, and the theory holds better

for countries with relatively low rates of inflation.

B) PPP holds up well over the short run but poorly for the long run, and the theory holds better

for countries with relatively high rates of inflation.

C) PPP holds up well over the long run but poorly for the short run, and the theory holds better

for countries with relatively low rates of inflation.

D) PPP holds up well over the long run but poorly for the short run, and the theory holds better

for countries with relatively high rates of inflation.

Answer: D

Diff: 1

L.O.: 6.1 Prices and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

11) A country's currency that strengthened relative to another country's currency by more than

that justified by the differential in inflation is said to be ________ in terms of PPP.

A) overvalued

B) overcompensating

C) undervalued

D) undercompensating

Answer: A

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

12) If we set the real effective exchange rate index between Canada and the United States equal

to 100 in 1998, and find that the U.S. dollar has risen to a value of 112.6, then from a

competitive perspective the U.S. dollar is:

A) overvalued.

B) undervalued.

C) very competitive.

D) There is not enough information to answer this question.

Answer: A

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

13) If we set the real effective exchange rate index between the United Kingdom and the United

States equal to 100 in 2005, and find that the U.S. dollar has changed to a value of 91.4, then

from a competitive perspective the U.S. dollar is:

A) overvalued.

B) undervalued.

C) equally valued.

D) There is not enough information to answer this question.

Answer: B

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

14) The government just released international exchange rate statistics and reported that the real

effective exchange rate index for the U.S. dollar vs. the Japanese yen decreased from 105 last

year to 95 currently and is expected to fall still further in the coming year. Other things equal,

U.S. ________ to/from Japan think this is good news, and U.S. ________ to/from Japan think

this is bad news.

A) importers; exporters

B) importers; importers

C) exporters; exporters

D) exporters; importers

Answer: D

Diff: 3

L.O.: 6.1 Prices and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

15) Exchange rate pass-through may be defined as:

A) the bid/ask spread on currency exchange rate transactions.

B) the degree to which the prices of imported and exported goods change as a result of exchange

rate changes.

C) the PPP of lesser-developed countries.

D) the practice by Great Britain of maintaining the relative strength of the currencies of the

Commonwealth countries under the current floating exchange rate regime.

Answer: B

Diff: 1

L.O.: 6.1 Prices and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

16) Phillips NV produces DVD players and exports them to the United States. Last year the

exchange rate was $1.25/euro and Phillips charged 120 euro per player in Euroland and $150 per

DVD player in the United States. Currently the spot exchange rate is $1.45/euro and Phillips is

charging $160 per DVD player. What is the degree of pass through by Phillips NV on their DVD

players?

A) 92%

B) 33.3%

C) 41.7%

D) 4.1%

Answer: C

Diff: 3

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

17) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in

the UK with a 20% margin for a price of £27,363. Today these cars are available in the U.S. for

$55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has

committed to keeping the U.S. price at $55,000 for the next six months. If the UK pound

appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against

currency changes, what is the amount the company will receive in pounds at the new exchange

rate?

A) £22,803

B) £25,581

C) £27,363

D) £55,000

Answer: B

Diff: 3

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

18) Jaguar has full manufacturing costs of their S-type sedan of £22,803. They sell the S-type in

the UK with a 20% margin for a price of £27,363. Today these cars are available in the U.S. for

$55,000 which is the UK price multiplied by the current exchange rate of $2.01/£. Jaguar has

committed to keeping the U.S. price at $55,000 for the next six months. If the UK pound

appreciates against the USD to an exchange rate of $2.15/£, and Jaguar has not hedged against

currency changes, what is the percentage margin the company will realize given the new

exchange rate?

A) 20.0%

B) 15.3%

C) 12.2%

D) 7.2%

Answer: C

Diff: 3

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

19) The price elasticity of demand for DVD players manufactured by Sony of Japan is greater

than one. If the Japanese yen appreciates against the U.S. dollar by 10% and the price of the

Sony DVD players in the U.S also rises by 10%, then other things equal, the total dollar sales

revenues of Sony DVDs would:

A) decline.

B) increase.

C) stay the same.

D) insufficient information

Answer: A

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

20) If a market basket of goods cost $100 in the U.S. and €70 in France, then the PPP exchange

rate would be $.70/€.

Answer: FALSE

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

21) The assumptions for relative PPP are more rigid than the assumptions for absolute PPP.

Answer: FALSE

Diff: 1

L.O.: 6.1 Prices and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

22) Empirical tests prove that PPP is an accurate predictor of future exchange rates.

Answer: FALSE

Diff: 1

L.O.: 6.1 Prices and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

23) Consider the price elasticity of demand. If a product has price elasticity less than one, it is

considered to have relatively elastic demand.

Answer: FALSE

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

24) The authors state that empirical tests of purchasing power parity "have, for the most part, not

proved PPP to be accurate in predicting future exchange rates." The authors then state that PPP

does hold up reasonably well in two situations. What are some reasons why PPP does not

accurately predict future exchange rates, and under what conditions might we reasonably expect

PPP to hold?

Answer: PPP does not hold because goods and services do not move without cost between

countries and markets. Often, goods and services are nor perfect substitutes in every market for

reasons of availability, taste, quality, and production techniques. Having said that, PPP does

appear to work reasonably well over the long run and especially in countries with higher rates of

inflation and underdeveloped capital markets.

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

25) The Big Mac is considered a good candidate for the application of the law of one price and

measurement of under- or overvaluation of a currency. Develop an argument as to why this is a

good idea.

Answer: First, the product itself is nearly identical in each market. This is the result of product

consistency, process excellence, and McDonald's brand image and pride. Second, and just as

important, the product is a result of predominantly local materials and input costs. This means

that its price in each country is representative of domestic costs and prices and not imported

ones, which would be influenced by exchange rates themselves. The index, however, still

possesses limitations. Big Macs cannot be traded across borders, and costs and prices are

influenced by a variety of other factors in each country market, such as real estate rental rates

and taxes.

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

26) Explain the logic behind the application of the PPP theory to explain changes in the spot

exchange rate.

Answer: The logic behind the application of PPP to changes in the spot exchange rate is that if a

country experiences inflation rates higher than those of its main trading partners, and its

exchange rate does not change, its exports of goods and services become less competitive with

comparable products produced elsewhere. Imports from abroad become more price-competitive

with higher-priced domestic products. These price changes lead to a deficit on the current

account in the balance of payments unless offset by capital and financial flows.

Diff: 2

L.O.: 6.1 Prices and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

6.2 Interest Rates and Exchange Rates

1) ________ states that nominal interest rates in each country are equal to the required real rate

of return plus compensation for expected inflation.

A) Absolute PPP

B) Relative PPP

C) The Law of One Price

D) The Fisher Effect

Answer: D

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

2) In its approximate form the Fisher effect may be written as ________, where i = the nominal

rate of interest, r = the real rate of return and π = the expected rate of inflation.

A) i = (r)(π)

B) i = r + π + (r)(π)

C) i = r + π

D) i = r + 2π

Answer: C

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

3) Assume a nominal interest rate on one-year U.S. Treasury Bills of 2.60% and a real rate of

interest of 1.00%. Using the Fisher Effect Equation, what is the approximate expected rate of

inflation in the U.S. over the next year?

A) 2.10%

B) 2.05%

C) 1.60%

D) 1.00%

Answer: C

Diff: 2

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Application of knowledge

4) Assume a nominal interest rate on one-year U.S. Treasury Bills of 3.80% and a real rate of

interest of 2.00%. Using the Fisher Effect Equation, what is the exact expected rate of inflation

in the U.S. over the next year?

A) 1.84%

B) 1.80%

C) 1.76%

D) 1.72%

Answer: C

Diff: 3

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

5) The relationship between the percentage change in the spot exchange rate over time and the

differential between comparable interest rates in different national capital markets is known as:

A) absolute PPP.

B) the law of one price.

C) relative PPP.

D) the international Fisher Effect.

Answer: D

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

6) According to the international Fisher Effect, if an investor purchases a five-year U.S. bond

that has an annual interest rate of 5% rather than a comparable British bond that has an annual

interest rate of 6%, then the investor must be expecting the ________ to ________ at a rate of at

least 1% per year over the next 5 years.

A) British pound; appreciate

B) British pound; revalue

C) U.S. dollar; appreciate

D) U.S. dollar; depreciate

Answer: C

Diff: 2

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

7) ________ states that the spot exchange rate should change in an equal amount but in the

opposite direction to the difference in interest rates between two countries.

A) Fisher-open

B) Fisher-closed

C) The Fisher Effect

D) none of the above

Answer: A

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

8) A ________ is an exchange rate quoted today for settlement at some time in the future.

A) spot rate

B) forward rate

C) currency rate

D) yield curve

Answer: B

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

9) Assume the current U.S. dollar-British spot rate is £0.6993/$. If the current nominal one-year

interest rate in the U.S. is 5% and the comparable rate in Britain is 6%, what is the approximate

forward exchange rate for 360 days?

A) £1.42/$

B) £1.43/$

C) £0.6993/$

D) £0.7060/$

Answer: D

Diff: 3

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

10) Assume the current U.S. dollar-yen spot rate is ¥90/$. Further, the current nominal 180-day

rate of return in Japan is 1% and 2% in the United States. What is the approximate forward

exchange rate for 180 days?

A) ¥89.12/$

B) ¥89.55/$

C) ¥90.89/$

D) ¥90.45/$

Answer: B

Diff: 3

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

11) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is

¥127/$ then the yen is selling at a per annum ________ of ________.

A) premium; 1.57%

B) premium; 6.30%

C) discount; 1.57%

D) discount; 6.30%

Answer: D

Diff: 3

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

12) The forward rate is calculated from all the following observable data items EXCEPT:

A) the forecast of the future spot exchange rate.

B) the home currency deposit rate.

C) the foreign currency deposit rate.

D) the spot exchange rate.

Answer: A

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

13) The theory of ________ states that the difference in the national interest rates for securities

of similar risk and maturity should be equal to but opposite in sign to the forward rate discount or

premium for the foreign currency, except for transaction costs.

A) international Fisher Effect

B) absolute PPP

C) interest rate parity

D) the law of one price

Answer: C

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

14) With covered interest arbitrage:

A) the market must be out of equilibrium.

B) a "riskless" arbitrage opportunity exists.

C) the arbitrageur trades in both the spot and future currency exchange markets.

D) all of the above

Answer: D

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

15) Arbitragers applying Covered Interest Arbitrage drive the international currency and money

markets toward the equilibrium described by:

A) the effective exchange rate index.

B) the purchasing power parity.

C) the nominal effective exchange rate index.

D) the interest rate parity.

Answer: D

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

16) Covered interest arbitrage moves the market ________ equilibrium because ________.

A) toward; purchasing a currency on the spot market and selling in the forward market narrows

the differential between the two

B) toward; investors are now more willing to invest in risky securities

C) away from; purchasing a currency on the spot market and selling in the forward market

increases the differential between the two

D) away from; demand for the stronger currency forces up interest rates on the weaker security

Answer: A

Diff: 2

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

17) The final component of the equation for the Fisher Effect, (r)(π), where r = the real rate of

return and π = the expected rate of inflation, is often dropped from the equation because the

number is simply too large for most Western economies.

Answer: FALSE

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

18) Empirical studies show that the Fisher Effect works best for short-term securities.

Answer: TRUE

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Recognition

AACSB: Application of knowledge

19) The current U.S. dollar-yen spot rate is ¥125/$. If the 90-day forward exchange rate is

¥127/$ then the yen is at a forward premium.

Answer: FALSE

Diff: 2

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

20) The premium or discount on forward currency exchange rates between any two countries is

visually obvious when you plot the interest rates of each country on the same yield curve. The

currency of the country with the higher yield curve should be selling at a forward discount.

Answer: TRUE

Diff: 2

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

21) Use interest rate parity to answer this question. A U.S. investor has a choice between a risk-

free one-year U.S. security with an annual return of 4%, and a comparable British security with a

return of 5%. If the spot rate is $1.43/£, the forward rate is $1.44/£, and there are no transaction

costs, the investor should invest in the U.S. security.

Answer: FALSE

Diff: 2

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

22) Both covered and uncovered interest arbitrage are risky operations in the sense that even

without default in the securities, the returns are unknown until all transactions are complete.

Answer: FALSE

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

23) All that is required for a covered interest arbitrage profit is for interest rate parity to not hold.

Answer: TRUE

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

24) COVERED interest arbitrage (CIA), is where investors borrow in countries and currencies

exhibiting relatively low interest rates and convert the proceeds into currencies that offer much

higher interest rates. The transaction is "covered," because the investor does not sell the higher

yielding currency proceeds forward.

Answer: FALSE

Diff: 1

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

25) The authors describe an application of uncovered interest arbitrage (UIA) known as "yen

carry trade." Define UIA and describe the example of yen carry trade. Why would an investor

engage in the practice of yen carry trade and is there any risk of loss or lesser profit from this

investment strategy?

Answer: UIA is the practice of investors borrowing money in countries where interest rates are

relatively low, converting the loan proceeds into a currency where rates are relatively high,

investing at the higher rate, subsequently converting the proceeds back into the original currency

to repay the proceeds from the loan and hopefully realizing a greater return from this practice

than if the borrowing and investing had all taken place in the original currency. The arbitrage is

uncovered because at the time of the investment the investor does not lock in a forward exchange

rate and therefore bears the risk that currency exchange rates will change in an unfavorable

manner. The yen carry trade exists because rates in Japan are so very low that investors borrow

yen, convert to another currency, say U.S. dollars, invest at much higher interest rates, often in

default-risk free Treasury securities, then convert back to yen, repay the original loan and walk

away with a significantly greater return than otherwise available. The risk in this process is

neither from the investment nor from the loan. The risk is that exchange rates may change

unfavorably and the investor takes a loss rather than a profit.

Diff: 3

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Analytical

AACSB: Analytical thinking

26) The Fisher Effect is a familiar economic theory in the domestic market. In words, define the

Fisher Effect and explain why you think it is also appropriately applied to international markets.

Answer: Irving Fisher was an early 20th century economist who hypothesized that all market

determined nominal interest rates had at least two basic components. First, a real return is

required to compensate investors for postponing current consumption. This real rate is constant

and unaffected by expectations about inflation. Second, an expected inflation component is

required so that investors would not expect to lose purchasing power by the act of forgoing

current consumption. Intuitively, if capital can move freely among international markets these

same requirements must exist in each of the capital markets and the Fisher Effect would apply

internationally as well as domestically.

Diff: 2

L.O.: 6.2 Interest Rates and Exchange Rates

Skill: Conceptual

AACSB: Application of knowledge

6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

1) If the forward rate is an unbiased predictor of the expected spot rate, which of the following is

NOT true?

A) The expected value of the future spot rate at time 2 equals the present forward rate for time 2

delivery, available now.

B) The distribution of possible actual spot rates in the future is centered on the forward rate.

C) The future spot rate will actually be equal to what the forward rate predicts.

D) All of the above are true.

Answer: C

Diff: 2

L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT an assumption of market efficiency?

A) Instruments denominated in other currencies are perfect substitutes for one another.

B) Transaction costs are low or nonexistent.

C) All relevant information is quickly reflected in both spot and forward exchange markets.

D) All of the above are true.

Answer: D

Diff: 1

L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

Skill: Recognition

AACSB: Application of knowledge

3) Empirical tests have yielded ________ evidence about market efficiency with a general

consensus that developing foreign markets are ________.

A) conflicting; not efficient

B) conflicting; efficient

C) consistent; inefficient

D) none of the above

Answer: A

Diff: 2

L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

Skill: Recognition

AACSB: Application of knowledge

4) If exchange markets were not efficient, it would pay for a firm to spend resources on

forecasting exchange rates.

Answer: TRUE

Diff: 1

L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

Skill: Conceptual

AACSB: Application of knowledge

5) If the forward exchange rate is an unbiased predictor of future spot rates, then future spot rates

will always be equal to current forward rates.

Answer: FALSE

Diff: 1

L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

Skill: Conceptual

AACSB: Application of knowledge

6) If exchange markets were efficient, the deviation of the actual future quote and today's

forward rate will be zero.

Answer: FALSE

Diff: 1

L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

Skill: Conceptual

AACSB: Application of knowledge

7) Some forecasters believe that foreign exchange markets for the major floating currencies are

"efficient" and forward exchange rates are unbiased predictors of future spot exchange rates.

Explain the rationale of this statement including the assumptions made, the meaning of

"efficient" and "unbiased," and the empirical evidence.

Answer: If the forward rate is an unbiased predictor of the future spot rate, the expected value of

the future spot rate at time 2 equals the present forward rate for time 2 delivery, available now,

E1(S2) = F1,2. Intuitively, this means that the distribution of possible actual spot rates in the

future is centered on the forward rate. The fact that it is an unbiased predictor, however, does not

mean that the future spot rate will actually be equal to what the forward rate predicts. Unbiased

prediction simply means that the forward rate will, on average, overestimate and underestimate

the actual future spot rate in equal frequency and degree. The forward rate may, in fact, never

actually equal the future spot rate.

The rationale for this relationship is based on the hypothesis that the foreign exchange market is

reasonably efficient. Market efficiency assumes that 1) All relevant information is quickly

reflected in both the spot and forward exchange markets; 2) Transaction costs are low; and

3) Instruments denominated in different currencies are perfect substitutes for one another.

Empirical studies of the efficient foreign exchange market hypothesis have yielded conflicting

results. Nevertheless, a consensus is developing that rejects the efficient market hypothesis. It

appears that the forward rate is not an unbiased predictor of the future spot rate and that it does

pay to use resources to attempt to forecast exchange rates.

Diff: 2

L.O.: 6.3 Forward Rate as an Unbiased Predictor of the Future Spot Rate

Skill: Conceptual

AACSB: Application of knowledge

6.4 Prices, Interest Rates, and Exchange Rates in Equilibrium

1) According to the International Fisher Effect, the forecast change in the spot rate between two

countries is equal to:

A) the current spot rate multiplied by the ratio of the inflation rates in the respective countries.

B) but the opposite sign to the difference between nominal interest rates.

C) but the opposite sign to the difference between inflation rates.

D) but the opposite sign to the difference between real interest rates.

Answer: B

Diff: 1

L.O.: 6.4 Prices, Interest Rates, and Exchange Rates in Equilibrium

Skill: Recognition

AACSB: Application of knowledge

2) In their approximate form, PPP, IRP, and forward rates as an unbiased predictor of the future

spot rate lead to similar forecasts of the future spot rate.

Answer: TRUE

Diff: 1

L.O.: 6.4 Prices, Interest Rates, and Exchange Rates in Equilibrium

Skill: Recognition

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 7 Foreign Currency Derivatives: Futures and Options

7.1 Foreign Currency Futures

1) Financial derivatives are powerful tools that can be used by management for purposes of:

A) speculation.

B) hedging.

C) human resource management.

D) A and B above

Answer: D

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Recognition

AACSB: Application of knowledge

2) A foreign currency ________ contract calls for the future delivery of a standard amount of

foreign exchange at a fixed time, place, and price.

A) futures

B) forward

C) option

D) swap

Answer: A

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Recognition

AACSB: Application of knowledge

3) Which of the following is NOT a contract specification for currency futures trading on an

organized exchange?

A) size of the contract

B) maturity date

C) last trading day

D) All of the above are specified.

Answer: D

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Recognition

AACSB: Application of knowledge

4) About ________ of all futures contracts are settled by physical delivery of foreign exchange

between buyer and seller.

A) 0%

B) 5%

C) 50%

D) 95%

Answer: B

Diff: 2

L.O.: 7.1 Foreign Currency Futures

Skill: Analytical

AACSB: Analytical thinking

5) Futures contracts require that the purchaser deposit an initial sum as collateral. This deposit is

called a:

A) collateralized deposit.

B) marked market sum.

C) margin.

D) settlement.

Answer: C

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Recognition

AACSB: Application of knowledge

6) A speculator in the futures market wishing to lock in a price at which they could ________ a

foreign currency will ________ a futures contract.

A) buy; sell

B) sell; buy

C) buy; buy

D) none of the above

Answer: C

Diff: 2

L.O.: 7.1 Foreign Currency Futures

Skill: Conceptual

AACSB: Application of knowledge

7) A speculator that has ________ a futures contract has taken a ________ position.

A) sold; long

B) purchased; short

C) sold; short

D) purchased; sold

Answer: C

Diff: 2

L.O.: 7.1 Foreign Currency Futures

Skill: Recognition

AACSB: Application of knowledge

8) Peter Simpson thinks that the U.K. pound will cost $1.43/£ in six months. A 6-month currency

futures contract is available today at a rate of $1.44/£. If Peter was to speculate in the currency

futures market, and his expectations are correct, which of the following strategies would earn

him a profit?

A) Sell a pound currency futures contract.

B) Buy a pound currency futures contract.

C) Sell pounds today.

D) Sell pounds in six months.

Answer: A

Diff: 3

L.O.: 7.1 Foreign Currency Futures

Skill: Analytical

AACSB: Analytical thinking

9) Jack Hemmings bought a 3-month British pound futures contract for $1.4400/£ only to see the

dollar appreciate to a value of $1.4250 at which time he sold the pound futures. If each pound

futures contract is for an amount of £62,500, how much money did Jack gain or lose from his

speculation with pound futures?

A) $937.50 loss

B) $937.50 gain

C) £937.50 loss

D) £937.50 gain

Answer: A

Diff: 3

L.O.: 7.1 Foreign Currency Futures

Skill: Analytical

AACSB: Analytical thinking

10) Which of the following statements regarding currency futures contracts and forward

contracts is NOT true?

A) A futures contract is a standardized amount per currency whereas the forward contact is for

any size desired.

B) A futures contract is for a fixed maturity whereas the forward contract is for any maturity you

like up to one year.

C) Futures contracts trade on organized exchanges whereas forwards take place between

individuals and banks with other banks via telecom linkages.

D) All of the above are true.

Answer: D

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Conceptual

AACSB: Application of knowledge

11) Which of the following is NOT a difference between a currency futures contract and a

forward contract?

A) The futures contract is marked to market daily, whereas the forward contract is only due to be

settled at maturity.

B) The counterparty to the futures participant is unknown with the clearinghouse stepping into

each transaction, whereas the forward contract participants are in direct contact setting the

forward specifications.

C) A single sales commission covers both the purchase and sale of a futures contract, whereas

there is no specific sales commission with a forward contract because banks earn a profit through

the bid-ask spread.

D) All of the above are true.

Answer: D

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Conceptual

AACSB: Application of knowledge

12) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign

currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-

month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six

months. Jasper should ________ at ________ to profit from changing currency values.

A) buy yen; the forward rate

B) buy dollars; the forward rate

C) sell yen; the forward rate

D) There is not enough information to answer this question.

Answer: A

Diff: 3

L.O.: 7.1 Foreign Currency Futures

Skill: Conceptual

AACSB: Application of knowledge

13) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign

currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-

month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six

months. If Jasper buys $100,000 worth of yen at today's spot price and sells within the next six

months at ¥128/$, he will earn a profit of:

A) $146.09.

B) $101,460.94.

C) $1460.94.

D) nothing; he will lose money

Answer: C

Diff: 3

L.O.: 7.1 Foreign Currency Futures

Skill: Analytical

AACSB: Analytical thinking

14) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign

currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-

month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six

months. If Jasper buys $100,000 worth of yen at today's spot price her potential gain is ________

and her potential loss is ________.

A) $100,000; unlimited

B) unlimited; unlimited

C) $100,000; $100,000

D) unlimited; $100,000

Answer: D

Diff: 3

L.O.: 7.1 Foreign Currency Futures

Skill: Analytical

AACSB: Analytical thinking

15) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign

currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-

month forward rate is ¥128.53/$. Jasper thinks the yen will move to ¥128.00/$ in the next six

months. If Jasper's expectations are correct, then he could profit in the forward market by

________ and then ________.

A) buying yen for ¥128.00/$; selling yen at ¥128.53/$

B) buying yen for ¥128.53/$; selling yen at ¥128.00/$

C) There is not enough information to answer this question.

D) He could not profit in the forward market.

Answer: B

Diff: 3

L.O.: 7.1 Foreign Currency Futures

Skill: Analytical

AACSB: Analytical thinking

16) Currency futures contracts have become standard fare and trade readily in the world money

centers.

Answer: TRUE

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Recognition

AACSB: Application of knowledge

17) The major difference between currency futures and forward contracts is that futures contracts

are standardized for ease of trading on an exchange market whereas forward contracts are

specialized and tailored to meet the needs of clients.

Answer: TRUE

Diff: 1

L.O.: 7.1 Foreign Currency Futures

Skill: Recognition

AACSB: Application of knowledge

18) Jasper Pernik is a currency speculator who enjoys "betting" on changes in the foreign

currency exchange market. Currently the spot price for the Japanese yen is ¥129.87/$ and the 6-

month forward rate is ¥128.53/$. Jasper would earn a higher rate of return by buying yen and

selling a forward contract than if he had invested her money in 6-month U.S. Treasury securities

at an annual rate of 2.50%.

Answer: FALSE

Diff: 3

L.O.: 7.1 Foreign Currency Futures

Skill: Analytical

AACSB: Analytical thinking

19) Why are foreign currency futures contracts more popular with individuals and banks while

foreign currency forwards are more popular with businesses?

Answer: Foreign currency futures are standardized contracts that lend themselves well to

speculation purposes but less so for hedging purposes. The standardized nature of the futures

contract makes it easy to trade futures and to make bets about general changes in the value of

currencies. Forward contracts are better for hedging in that they are tailored to meet the specific

needs of the client, typically a business, and can be quite useful in reducing exchange rate risk.

Banks are involved in the foreign currency futures market in part to offset positions that they

may have taken in the forward markets as dealers.

Diff: 2

L.O.: 7.1 Foreign Currency Futures

Skill: Conceptual

AACSB: Application of knowledge

7.2 Foreign Currency Options

1) A foreign currency ________ gives the purchaser the right, not the obligation, to buy a given

amount of foreign exchange at a fixed price per unit for a specified period.

A) future

B) forward

C) option

D) swap

Answer: C

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

2) A foreign currency ________ option gives the holder the right to ________ a foreign

currency, whereas a foreign currency ________ option gives the holder the right to ________ an

option.

A) call, buy, put, sell

B) call, sell, put, buy

C) put, hold, call, release

D) none of the above

Answer: A

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

3) The price at which an option can be exercised is called the:

A) premium.

B) spot rate.

C) strike price.

D) commission.

Answer: C

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

4) A/An ________ option can be exercised only on its expiration date, whereas a/an ________

option can be exercised anytime between the date of writing up to and including the exercise

date.

A) American; European

B) American; British

C) Asian; American

D) European; American

Answer: D

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

5) A/An ________ option can be exercised only on its expiration date, whereas a/an ________

option can be exercised anytime between the date of writing up to and including the exercise

date.

A) American; European

B) American; British

C) Asian; American

D) European; American

Answer: D

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

6) A call option whose exercise price exceeds the spot price is said to be:

A) in-the-money.

B) at-the-money.

C) out-of-the-money.

D) over-the-spot.

Answer: C

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

7) A call option whose exercise price is less than the spot price is said to be:

A) in-the-money.

B) at-the-money.

C) out-of-the-money.

D) under-the-spot.

Answer: A

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

8) An option whose exercise price is equal to the spot rate is said to be:

A) in-the-money.

B) at-the-money.

C) out-of-the-money.

D) on-the-spot.

Answer: B

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

9) The main advantage(s) of over-the-counter foreign currency options over exchange traded

options is (are):

A) expiration dates tailored to the needs of the client.

B) amounts that are tailor made.

C) client desired expiration dates.

D) all of the above

Answer: D

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

10) As a general statement, it is safe to say that businesses generally use the ________ for

foreign currency option contracts, and individuals and financial institutions typically use the

________.

A) exchange markets; over-the-counter

B) over-the-counter; exchange markets

C) private; government sponsored

D) government sponsored; private

Answer: B

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

TABLE 7.1

Use the table to answer following question(s).

April 19, 2009, British Pound Option Prices (cents per pound, 62,500 pound contracts).

11) Refer to Table 7.1. What was the closing price of the British pound on April 18, 2009?

A) $1.448/£

B) £1.448/$

C) $14.48/£

D) none of the above

Answer: A

Diff: 3

L.O.: 7.2 Foreign Currency Options

Skill: Analytical

AACSB: Analytical thinking

12) Refer to Table 7.1. The exercise price of ________ giving the purchaser the right to sell

pounds in June has a cost per pound of ________ for a total price of ________.

A) 1460; 0.68 cents; $425.00

B) 1440; 1.06 cents; $662.50

C) 1450; 1.02 cents; $637.50

D) 1440; 1.42 cents; $887.50

Answer: B

Diff: 3

L.O.: 7.2 Foreign Currency Options

Skill: Analytical

AACSB: Analytical thinking

13) Refer to Table 7.1. The May call option on pounds with a strike price of 1440 means:

A) $88/£ per contract.

B) $0.88/£.

C) $0.0088/£.

D) none of the above

Answer: C

Diff: 3

L.O.: 7.2 Foreign Currency Options

Skill: Analytical

AACSB: Analytical thinking

14) Dash Brevenshure works for the currency trading unit of ING Bank in London. He

speculates that in the coming months the dollar will rise sharply vs. the pound. What should

Dash do to act on his speculation?

A) Buy a call on the pound.

B) Sell a call on the pound.

C) Buy a put on the pound.

D) Sell a put on the pound.

Answer: C

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

15) A put option on yen is written with a strike price of ¥105.00/$. Which spot price maximizes

your profit if you choose to exercise the option before maturity?

A) ¥100/$

B) ¥105/$

C) ¥110/$

D) ¥115/$

Answer: D

Diff: 3

L.O.: 7.2 Foreign Currency Options

Skill: Analytical

AACSB: Analytical thinking

16) A call option on euros is written with a strike price of $1.30/euro. Which spot price

maximizes your profit if you choose to exercise the option before maturity?

A) $1.20/euro

B) $1.25/euro

C) $1.30/euro

D) $1.35/euro

Answer: D

Diff: 3

L.O.: 7.2 Foreign Currency Options

Skill: Analytical

AACSB: Analytical thinking

17) A call option on UK pounds has a strike price of $2.05/£ and a cost of $0.02. What is the

break-even price for the option?

A) $2.03/£

B) $2.07/£

C) $2.05/£

D) The answer depends upon if this is a long or a short call option.

Answer: B

Diff: 3

L.O.: 7.2 Foreign Currency Options

Skill: Analytical

AACSB: Analytical thinking

18) Your U.S firm has an accounts payable denominated in UK pounds due in 6 months. To

protect yourself against unexpected changes in the dollar/pound exchange rate you should:

A) buy a pound put option.

B) sell a pound put option.

C) buy a pound call option.

D) sell a pound call option.

Answer: C

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

19) The maximum gain for the purchaser of a call option contract is ________ while the

maximum loss is ________.

A) unlimited; the premium paid.

B) the premium paid; unlimited.

C) unlimited; unlimited.

D) unlimited; the value of the underlying asset.

Answer: A

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

20) The buyer of a long call option:

A) has a maximum loss equal to the premium paid.

B) has a gain equal to but opposite in sign to the writer of the option.

C) has an unlimited maximum gain potential.

D) all of the above

Answer: D

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

21) Which of the following is NOT true for the writer of a call option?

A) The maximum loss is unlimited.

B) The maximum gain is unlimited.

C) The gain or loss is equal to but of the opposite sign of the buyer of a call option.

D) All of the above are true.

Answer: B

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

22) Which of the following is NOT true for the writer of a put option?

A) The maximum loss is limited to the strike price of the underlying asset less the premium.

B) The gain or loss is equal to but of the opposite sign of the buyer of a put option.

C) The maximum gain is the amount of the premium.

D) All of the above are true.

Answer: D

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

23) The buyer (long) of a put option:

A) has a maximum loss equal to the premium paid.

B) has a gain equal to but opposite in sign to the writer of the option.

C) has maximum gain potential limited to the difference between the strike price and the

premium paid.

D) all of the above

Answer: D

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

24) The value of a European style call option is the sum of two components:

A) the present value plus the intrinsic value.

B) the time value plus the present value.

C) the intrinsic value plus the time value.

D) the intrinsic value plus the standard deviation.

Answer: C

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

25) The writer of the option is referred to as the seller, and the buyer of the option is referred to

as the holder.

Answer: TRUE

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

26) Foreign currency options are available both over-the-counter and on organized exchanges.

Answer: TRUE

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Recognition

AACSB: Application of knowledge

27) Most option profits and losses are realized through taking actual delivery of the currency

rather than offsetting contracts.

Answer: FALSE

Diff: 1

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

28) Compare and contrast foreign currency options and futures. Identify situations when you

may prefer one vs. the other when speculating on foreign exchange.

Answer: Foreign currency futures are derivative securities that allow the holder to lock in a price

today for another currency at some point in the future. The foreign currency future contract is an

obligation on the part of the parties to fulfill the terms of the contract. Even if prices change in an

unanticipated way, the parties are obligated to fulfill the terms of the contract. The foreign

currency option contract on the other hand is a right not an obligation to purchase/sell a currency

at some point in the future at a price agreed upon today. If prices change in an unexpected

manner, the buyer of the contract is under no obligation to exercise the contract. Option contracts

are better suited to situations where price changes are anticipated, but the direction of the change

is highly uncertain.

Diff: 2

L.O.: 7.2 Foreign Currency Options

Skill: Conceptual

AACSB: Application of knowledge

7.3 Option Pricing and Valuation

1) Which of the following is NOT a factor in determining the premium price of a currency

option?

A) the present spot rate

B) the time to maturity

C) the standard deviation of the daily spot price movement

D) All of the above are factors in determining the premium price.

Answer: D

Diff: 1

L.O.: 7.3 Option Pricing and Valuation

Skill: Recognition

AACSB: Application of knowledge

2) The ________ of an option is the value if the option were to be exercised immediately. It is

the option's ________ value.

A) intrinsic value; maximum

B) intrinsic value; minimum

C) time value; maximum

D) time value; minimum

Answer: B

Diff: 2

L.O.: 7.3 Option Pricing and Valuation

Skill: Recognition

AACSB: Application of knowledge

3) Assume that a call option has an exercise price of $1.50/£. At a spot price of $1.45/£, the call

option has:

A) a time value of $0.04.

B) a time value of $0.00.

C) an intrinsic value of $0.00.

D) an intrinsic value of -$0.04.

Answer: C

Diff: 2

L.O.: 7.3 Option Pricing and Valuation

Skill: Analytical

AACSB: Analytical thinking

4) The time value is asymmetric in value as you move away from the strike price (i.e., the time

value at two cents above the strike price is not necessarily the same as the time value two cents

below the strike price).

Answer: FALSE

Diff: 2

L.O.: 7.3 Option Pricing and Valuation

Skill: Conceptual

AACSB: Application of knowledge

5) The price of an option is always somewhat greater than its intrinsic value, since there is

always some chance that the intrinsic value will rise between the present and the expiration date.

Answer: TRUE

Diff: 2

L.O.: 7.3 Option Pricing and Valuation

Skill: Conceptual

AACSB: Application of knowledge

6) Define and explain the logic for the time value of an option. Explain the value of the time

value of an option for deep out-of-the money and deep in-the-money options.

Answer: The time value of an option exists because the price of the underlying currency, the

spot rate, can potentially move further and further into the money before the option's expiration.

Time value is the area between the total value of the option and its intrinsic value. An investor

will pay something today for an out-of-the-money option (i.e., zero intrinsic value) on the chance

that the spot rate will move far enough before maturity to move the option in-the-money.

Consequently, the price of an option is always somewhat greater than its intrinsic value, since

there is always some chance — some might say 'hope everlasting' — that the intrinsic value will

rise by the expiration date. For deep out-of-the money and deep in-the-money options the value

of the time value of an option is insignificant since the chances for the option to increase in value

are slim.

Diff: 2

L.O.: 7.3 Option Pricing and Valuation

Skill: Conceptual

AACSB: Application of knowledge

7.4 Currency Option Pricing Sensitivity

1) If the spot rate changes from $1.70/£ to $1.71/£ and there is an option with an initial premium

of $0.033/£ and a delta of 0.5, then the new option premium would be:

A) $0.043/£.

B) $0.038/£.

C) $0.005/£.

D) $1.715/£.

Answer: B

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

2) As an option moves further in-the-money, delta moves toward ________.

A) 0

B) -1

C) 1

D) large numbers

Answer: C

Diff: 3

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

3) As an option moves further out-of-the-money, delta moves toward ________.

A) 1

B) 0

C) -1

D) large negative numbers

Answer: B

Diff: 3

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

4) Option premiums deteriorate at a/an ________ as they approach expiration.

A) increasing rate

B) proportional

C) decreasing rate

D) less than proportional rate

Answer: A

Diff: 3

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

5) Volatility is viewed the following ways EXCEPT:

A) historic.

B) forward-looking.

C) implied.

D) spot.

Answer: D

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

6) For a $1.50/£ call option with an initial premium of $0.033/£ and a lambda of 0.4, after an

increase in annual volatility of 1 percent point — for example from 10% to 11% — the new

option premium would be:

A) $0.036/£.

B) $0.037/£.

C) $0.004/£.

D) $1.54/£.

Answer: B

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

7) Traders who believe volatilities will fall significantly in the near-term will:

A) sell futures now.

B) buy options now.

C) sell options now.

D) buy futures now.

Answer: C

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

8) For a $1.50/£ call option with an initial premium of $0.033/£ and a rho value of 0.2, after an

increase in the U.S. dollar rate from 8% to 9% — the new ATM option premium would be:

A) $0.037/£.

B) $1.55/£.

C) $0.036/£.

D) $0.035/£.

Answer: D

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

9) For a $1.50/£ call option with an initial premium of $0.033/£ and a phi value of -0.2, after an

increase in the foreign interest (the pound sterling rate) rate from 8% to 9% — the new option

premium would be:

A) $0.035/£.

B) $1.48/£.

C) $0.031/£.

D) $0.032/£.

Answer: C

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Analytical

AACSB: Analytical thinking

10) The Delta of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.

B) expected change in the option premium for a small change in volatility.

C) expected change in the option premium for a small change in the spot rate.

D) expected change in the option premium for a small change in the domestic interest rate.

Answer: C

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

11) The Theta of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.

B) expected change in the option premium for a small change in volatility.

C) expected change in the option premium for a small change in the spot rate.

D) expected change in the option premium for a small change in the domestic interest rate.

Answer: A

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

12) The Lambda of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.

B) expected change in the option premium for a small change in volatility.

C) expected change in the option premium for a small change in the spot rate.

D) expected change in the option premium for a small change in the domestic interest rate.

Answer: B

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

13) The Rho of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.

B) expected change in the option premium for a small change in volatility.

C) expected change in the option premium for a small change in the foreign interest rate.

D) expected change in the option premium for a small change in the domestic interest rate.

Answer: D

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

14) The Phi of an option is defined as:

A) expected change in the option premium for a small change in time to expiration.

B) expected change in the option premium for a small change in volatility.

C) expected change in the option premium for a small change in the foreign interest rate.

D) expected change in the option premium for a small change in the domestic interest rate.

Answer: C

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

15) Which of the following statements is NOT true about currency option pricing sensitivities?

A) The higher the delta, the more likely the option will move in-the-money.

B) Premiums rise with increases in volatility.

C) Premiums are relatively insensitive during the first days.

D) Increases in domestic interest rates cause decreasing call option premiums.

Answer: D

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

16) The time value is asymmetric in value as you move away from the strike price (i.e., the time

value at two cents above the strike price is not necessarily the same as the time value two cents

below the strike price).

Answer: FALSE

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Conceptual

AACSB: Application of knowledge

17) Standard foreign currency options are priced around the forward rate.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

18) As long as the option has time remaining before expiration, the option will possess time the

time value element.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

19) If an American-style option possesses time value on any day up to expiration date, the option

holder would get more by selling it than exercising it.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

20) The value of any option that is currently in-the-money (ITM) is made up entirely of time

value.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Conceptual

AACSB: Application of knowledge

21) The sensitivity of the option premium to a small change in the spot exchange rate is called

the gamma.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

22) If the rho of the specific option is known, it is easy to determine how the option's value will

change as the spot rate changes.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

23) The higher the delta the greater the probability of the option expiring in-the-money.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

24) Option values increase with the length of time to maturity. The expected change in the option

premium from a small change in the time to expiration is termed delta.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

25) The majority of the option premium is lost in the final days prior to expiration.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

26) A trader who is buying options of longer maturities will pay more, and proportionately more,

for the longer maturity options.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

27) Option volatility is defined as the square root of the standard deviation of daily percentage

changes in the underlying exchange rate.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

28) If the exchange rate's volatility is rising, and therefore the risk of the option not being

exercised is decreasing, the option premium would be increasing.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

29) The primary problem with volatility is that it is unobservable; it is the only input into the

option pricing formula that is determined subjectively by the trader pricing the option.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

30) Historical volatility is the correct method for the calculation of the option volatility.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

31) Traders by using the historical volatility assume that the immediate future will be the same as

the recent past, and the historical volatility will equal the forward-looking volatility.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

32) A trader who is purchasing a call option on foreign currency should do so before the

domestic interest rate rises.

Answer: TRUE

Diff: 2

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

33) The expected change in the option premium from a small change in the domestic interest rate

(home currency) is term rho.

Answer: TRUE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

34) The expected change in the option premium from a small change in the foreign interest rate

(foreign currency) is termed vega.

Answer: FALSE

Diff: 1

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Recognition

AACSB: Application of knowledge

35) List and explain three "Greek" elements and their impact on a call option premium.

Answer: 1) Delta: is the expected change in the option premium for a small change in the spot

rate. The higher the delta, the more likely the option will move in-the-money. 2) Theta: is the

expected change in the option premium for a small change in time to expiration. Premiums are

relatively insensitive until the final 30 or so days. 3) Lambda: is the expected change in the

option premium for a small change in volatility. Premiums rise with increases in volatility.

4) Rho: Expected change in the option premium for a small change in the domestic interest rate.

Increases in domestic interest rates cause increasing call option premiums. 5) Phi: Expected

change in the option premium for a small change in the foreign interest rate. Increases in foreign

interest rates cause decreasing call option premiums.

Diff: 3

L.O.: 7.4 Currency Option Pricing Sensitivity

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 8 Interest Risk and Swaps

8.1 Interest Rate Foundations

1) The single largest interest rate risk of a firm is:

A) interest sensitive securities.

B) debt service.

C) dividend payments.

D) accounts payable.

Answer: B

Diff: 2

L.O.: 8.1 Interest Rate Foundations

Skill: Recognition

AACSB: Application of knowledge

2) Historically, interest rate movements have shown less variability and greater stability than

exchange rate movements.

Answer: TRUE

Diff: 1

L.O.: 8.1 Interest Rate Foundations

Skill: Recognition

AACSB: Application of knowledge

3) Some of the world's largest and most financially sound firms may borrow at variable rates less

than LIBOR.

Answer: TRUE

Diff: 1

L.O.: 8.1 Interest Rate Foundations

Skill: Recognition

AACSB: Application of knowledge

4) The London Interbank Offered Rate (LIBOR) is published under the auspices of the British

Bankers Association. A panel of 16 major multinational banks self-report their actual borrowing

rate.

Answer: FALSE

Diff: 1

L.O.: 8.1 Interest Rate Foundations

Skill: Recognition

AACSB: Application of knowledge

5) Interest rate calculations differ by the number of days used in the period's calculation and in

the definition of how many days there are in a year (for financial purposes). One of the practices

is to use 260 business days in a year.

Answer: FALSE

Diff: 1

L.O.: 8.1 Interest Rate Foundations

Skill: Conceptual

AACSB: Application of knowledge

8.2 The Cost of Debt

1) ________ is the possibility that the borrower's creditworthiness is reclassified by the lender at

the time of renewing credit. ________ is the risk of changes in interest rates charged at the time a

financial contract rate is set.

A) Credit risk; Interest rate risk

B) Repricing risk; Credit risk

C) Interest rate risk; Credit risk

D) Credit risk; Repricing risk

Answer: D

Diff: 2

L.O.: 8.2 The Cost of Debt

Skill: Recognition

AACSB: Application of knowledge

2) Individual borrowers – whether they be governments or companies – possess their own

individual credit rating, the market's assessment of their ability to repay debt in a timely manner.

These credit assessments influence all the following EXCEPT:

A) cost of capital.

B) access to capital.

C) credit risk premium.

D) risk-free rate.

Answer: D

Diff: 2

L.O.: 8.2 The Cost of Debt

Skill: Conceptual

AACSB: Application of knowledge

3) The basis point spreads between credit ratings dramatically rise for borrowers of credit

qualities less than BBB.

Answer: TRUE

Diff: 2

L.O.: 8.2 The Cost of Debt

Skill: Recognition

AACSB: Application of knowledge

4) Sovereign credit risk is the global financial market's assessment of the ability of a sovereign

borrower to repay USD denominated debt.

Answer: FALSE

Diff: 2

L.O.: 8.2 The Cost of Debt

Skill: Recognition

AACSB: Application of knowledge

5) For a corporate borrower, it is especially important to distinguish between credit risk and

repricing risk. Explain both types of risks.

Answer: Credit risk, sometimes termed roll-over risk, is the possibility that a borrower's

creditworthiness at the time of renewing a credit — its credit rating — is reclassified by the

lender. This can result in changing fees, changing interest rates, altered credit line commitments,

or even denial. Repricing risk is the risk of changes in interest rates charged (earned) at the time

a financial contract's rate is reset. A borrower that is renewing a credit will face current market

conditions on the base rate used for financing, a true floating-rate.

Diff: 2

L.O.: 8.2 The Cost of Debt

Skill: Conceptual

AACSB: Application of knowledge

8.3 Interest Rate Risk

Instruction 8.1:

For the following problem(s), consider these debt strategies being considered by a corporate

borrower. Each is intended to provide $1,000,000 in financing for a three-year period.

• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.

• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset

annually. The current LIBOR rate is 3.50%

• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit

annually. The current one-year rate is 5%.

1) Refer to Instruction 8.1. Choosing strategy #1 will:

A) guarantee the lowest average annual rate over the next three years.

B) eliminate credit risk but retain repricing risk.

C) maintain the possibility of lower interest costs, but maximizes the combined credit and

repricing risks.

D) preclude the possibility of sharing in lower interest rates over the three-year period.

Answer: D

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

2) Refer to Instruction 8.1. Choosing strategy #2 will:

A) guarantee the lowest average annual rate over the next three years.

B) eliminate credit risk but retain repricing risk.

C) maintain the possibility of lower interest costs, but maximizes the combined credit and

repricing risks.

D) preclude the possibility of sharing in lower interest rates over the three-year period.

Answer: B

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

3) Refer to Instruction 8.1. Choosing strategy #3 will:

A) guarantee the lowest average annual rate over the next three years.

B) eliminate credit risk but retain repricing risk.

C) maintain the possibility of lower interest costs, but maximizes the combined credit and

repricing risks.

D) preclude the possibility of sharing in lower interest rates over the three-year period.

Answer: C

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

4) Refer to Instruction 8.1. Which strategy (strategies) will eliminate credit risk?

A) Strategy #1

B) Strategy #2

C) Strategy #3

D) Strategies #1 and #2

Answer: D

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

5) Refer to Instruction 8.1. If your firm felt very confident that interest rates would fall or, at

worst, remain at current levels, and were very confident about the firm's credit rating for the next

10 years, which strategy would you likely choose? (Assume your firm is borrowing money.)

A) Strategy #3

B) Strategy #2

C) Strategy #1

D) Strategy #1, #2, or #3; you are indifferent among the choices.

Answer: A

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

6) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that

your credit rating might improve. The risk of strategy #2 is: (Assume your firm is borrowing

money.)

A) that interest rates might go down or that your credit rating might improve.

B) that interest rates might go up or that your credit rating might improve.

C) that interest rates might go up or that your credit rating might get worse.

D) none of the above

Answer: B

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

7) Refer to Instruction 8.1. The risk of strategy #1 is that interest rates might go down or that

your credit rating might improve. The risk of strategy #3 is: (Assume your firm is borrowing

money.)

A) that interest rates might go down or that your credit rating might improve.

B) that interest rates might go up or that your credit rating might improve.

C) that interest rates might go up or that your credit rating might get worse.

D) none of the above

Answer: C

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

8) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer

strategy #1? (Assume your firm is borrowing money.)

A) Your credit rating stayed the same and interest rates went up.

B) Your credit rating stayed the same and interest rates went down.

C) Your credit rating improved and interest rates went down.

D) Not enough information to make a judgment.

Answer: A

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Conceptual

AACSB: Analytical thinking

9) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer

strategy #2? (Assume your firm is borrowing money.)

A) Your credit rating stayed the same and interest rates went up.

B) Your credit rating stayed the same and interest rates went down.

C) Your credit rating improved and interest rates went down.

D) Not enough information to make a judgment.

Answer: B

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

10) Refer to Instruction 8.1. After the fact, under which set of circumstances would you prefer

strategy #3? (Assume your firm is borrowing money.)

A) Your credit rating stayed the same and interest rates went up.

B) Your credit rating stayed the same and interest rates went down.

C) Your credit rating improved and interest rates went down.

D) Not enough information to make a judgment.

Answer: C

Diff: 2

L.O.: 8.3 Interest Rate Risk

Skill: Analytical

AACSB: Analytical thinking

11) Unlike the situation with exchange rate risk, there is no uncertainty on the part of

management for shareholder preferences regarding interest rate risk. Shareholders prefer that

managers hedge interest rate risk rather than having shareholders diversify away such risk

through portfolio diversification.

Answer: FALSE

Diff: 1

L.O.: 8.3 Interest Rate Risk

Skill: Conceptual

AACSB: Application of knowledge

8.4 Interest Rate Futures and FRAs

1) An interbank-traded contract to buy or sell interest rate payments on a notional principal is

called a/an:

A) forward rate agreement.

B) interest rate future.

C) interest rate swap.

D) none of the above

Answer: A

Diff: 1

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Recognition

AACSB: Application of knowledge

2) A/an ________ is a contract to lock in today interest rates over a given period of time.

A) forward rate agreement

B) interest rate future

C) interest rate swap

D) none of the above

Answer: B

Diff: 1

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Recognition

AACSB: Application of knowledge

3) The financial manager of a firm has a variable rate loan outstanding. If she wishes to protect

the firm against an unfavorable increase in interest rates she could:

A) sell an interest rate futures contract of a similar maturity to the loan.

B) buy an interest rate futures contract of a similar maturity to the loan.

C) swap the adjustable rate loan for another of a different maturity.

D) none of the above

Answer: A

Diff: 2

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Conceptual

AACSB: Application of knowledge

4) If a financial manager with an interest liability on a future date were to sell Futures and

interest rates end up going up, the position outcome would be:

A) Futures price falls; short earns a profit.

B) Futures price rises; short earns a loss.

C) Future price falls; long earns a loss.

D) Futures price rises; long earns a profit.

Answer: A

Diff: 2

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Analytical

AACSB: Analytical thinking

5) If a financial manager with an interest liability on a future date were to sell Futures and

interest rates end up going down, the position outcome would be:

A) Futures price falls; short earns a profit.

B) Futures price rises; short earns a loss.

C) Future price falls; long earns a loss.

D) Futures price rises; long earns a profit.

Answer: B

Diff: 2

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Analytical

AACSB: Analytical thinking

6) If a financial manager earning interest on a future date were to buy Futures and interest rates

end up going up, the position outcome would be:

A) Futures price falls; short earns a profit.

B) Futures price rises; short earns a loss.

C) Future price falls; long earns a loss.

D) Futures price rises; long earns a profit.

Answer: C

Diff: 2

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Analytical

AACSB: Analytical thinking

7) If a financial manager earning interest on a future date were to buy Futures and interest rates

end up going down, the position outcome would be:

A) Futures price falls; short earns a profit.

B) Futures price rises; short earns a loss.

C) Future price falls; long earns a loss.

D) Futures price rises; long earns a profit.

Answer: D

Diff: 2

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Analytical

AACSB: Analytical thinking

8) Interest rate futures are relatively unpopular among financial managers because of their

relative illiquidity and their difficulty of use.

Answer: FALSE

Diff: 1

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Recognition

AACSB: Application of knowledge

9) A basis point is one-tenth of one percent.

Answer: FALSE

Diff: 1

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Recognition

AACSB: Application of knowledge

10) Your firm is faced with paying a variable rate debt obligation with the expectation that

interest rates are likely to go up. Identify two strategies using interest rate futures and interest

rate swaps that could reduce the risk to the firm.

Answer: Sell a futures position. If rates change the payoff from the futures position offsets the

gain or loss on the variable rate debt obligation. Swap a variable rate debt obligation for a fixed

futures payable contract.

Diff: 3

L.O.: 8.4 Interest Rate Futures and FRAs

Skill: Conceptual

AACSB: Application of knowledge

8.5 Interest Rate Swaps

1) An agreement to swap a fixed interest payment for a floating interest payment would be

considered a/an:

A) currency swap.

B) forward swap.

C) interest rate swap.

D) none of the above

Answer: C

Diff: 1

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

2) An agreement to exchange interest payments based on a fixed payment for those based on a

variable rate (or vice versa) is known as a/an:

A) forward rate agreement.

B) interest rate future.

C) interest rate swap.

D) none of the above

Answer: C

Diff: 1

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

3) An agreement to swap the currencies of a debt service obligation would be termed a/an:

A) currency swap.

B) forward swap.

C) interest rate swap.

D) none of the above

Answer: A

Diff: 1

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following would be considered an example of a currency swap?

A) exchanging a dollar interest obligation for a British pound obligation

B) exchanging a eurodollar interest obligation for a dollar obligation

C) exchanging a eurodollar interest obligation for a British pound obligation

D) All of the above are examples of a currency swap.

Answer: D

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

5) A firm with fixed-rate debt that expects interest rates to fall may engage in a swap agreement

to:

A) pay fixed-rate interest and receive floating rate interest.

B) pay floating rate and receive fixed rate.

C) pay fixed rate and receive fixed rate.

D) pay floating rate and receive floating rate.

Answer: B

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

6) A firm with variable-rate debt that expects interest rates to rise may engage in a swap

agreement to:

A) pay fixed-rate interest and receive floating rate interest.

B) pay floating rate and receive fixed rate.

C) pay fixed rate and receive fixed rate.

D) pay floating rate and receive floating rate.

Answer: A

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

7) The interest rate swap strategy of a firm with fixed rate debt and that expects rates to go up is

to:

A) do nothing.

B) pay floating and receive fixed.

C) receive floating and pay fixed.

D) none of the above

Answer: A

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

8) Which of the following is an unlikely reason for firms to participate in the swap market?

A) To replace cash flows scheduled in an undesired currency with cash flows in a desired

currency.

B) Firms may raise capital in one currency but desire to repay it in another currency.

C) Firms desire to swap fixed and variable payment or receipt of funds.

D) All of the above are likely reasons for a firm to enter the swap market.

Answer: D

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

9) The potential exposure that any individual firm bears that the second party to any financial

contract will be unable to fulfill its obligations under the contract is called:

A) interest rate risk.

B) credit risk.

C) counterparty risk.

D) clearinghouse risk.

Answer: C

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

10) A swap agreement may involve currencies or interest rates, but never both.

Answer: FALSE

Diff: 1

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

11) One of the reasons companies use interest rate swaps is because they pursue a target debt

structure that combines maturity, currency of composition, and fixed/floating pricing.

Answer: TRUE

Diff: 1

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

12) One of the reasons companies use interest rate swaps is because they are interested in

opportunities to lower the cost of their debt.

Answer: TRUE

Diff: 1

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

13) Counterparty risk is greater for exchange-traded derivatives than for over-the-counter

derivatives.

Answer: FALSE

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

14) Swap rates are derived from the yield curves in each major currency.

Answer: TRUE

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

15) A firm entering into a currency or interest rate swap agreement holds no responsibility for

the timely servicing of its own debt obligations since that responsibility now is born by the

second party to the contract.

Answer: FALSE

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

16) The real exposure of an interest or currency swap is not the total notional principal, but the

mark-to-market values of differentials in interest or currency interest payments since the

inception of the swap agreement.

Answer: TRUE

Diff: 2

L.O.: 8.5 Interest Rate Swaps

Skill: Recognition

AACSB: Application of knowledge

17) Your firm is faced with paying a variable rate debt obligation with the expectation that

interest rates are likely to go up. Identify two strategies using interest rate futures and interest

rate swaps that could reduce the risk to the firm.

Answer: Sell a futures position. If rates change the payoff from the futures position offsets the

gain or loss on the variable rate debt obligation. Swap a variable rate debt obligation for a fixed

futures payable contract.

Diff: 3

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

18) How does counterparty risk influence a firm's decision to trade exchange-traded derivatives

rather than over-the-counter derivatives?

Answer: With exchange-traded derivatives, the exchange is the clearinghouse. Thus, firms do

not need to worry about the other party making good on its obligations and it is easier to trade

the derivative products.

Diff: 3

L.O.: 8.5 Interest Rate Swaps

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 9 Foreign Exchange Rate Determination and Intervention

9.1 Exchange Rate Determination: The Theoretical Thread

1) An important thing to remember about foreign exchange rate determination is that parity

conditions, asset approach, and balance of payments approaches are ________ theories rather

than ________ theories.

A) competing; complementary

B) competing; contemporary

C) complementary; contiguous

D) complementary; competing

Answer: D

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following did NOT contribute to the exchange rate collapse in emerging markets

in the 1990s?

A) infrastructure weaknesses

B) speculation on the part of market participants

C) the sharp reduction of cross-border foreign direct investment

D) All of the above contributed to the emerging markets exchange rate collapse of the 1990s.

Answer: D

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

3) The ________ provides a means to account for international cash flows in a standardized and

systematic manner.

A) parity conditions

B) asset approach

C) balance of payments

D) International Fisher Effect

Answer: C

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

4) The ________ approach argues that equilibrium exchange rates are achieved when the net

inflow of foreign exchange arising from current account activities is equal to the net outflow of

foreign exchange arising from financial account activities.

A) balance of payments

B) monetary

C) asset market

D) law of one price

Answer: A

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

5) The ________ approach states that the exchange rate is determined by the supply and demand

for national currency stocks, as well as the expected future levels and rates of growth of

monetary stock.

A) balance of payments

B) monetary

C) asset market

D) law of one price

Answer: B

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

6) The ________ approach argues that exchange rates are determined by the supply and demand

for a wide variety of financial assets

A) balance of payments

B) monetary

C) asset market

D) law of one price

Answer: C

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

7) The ________ approach to the determination of spot exchange rates hypothesizes that the

most important factors are the relative real interest rate and a country's outlook for economic

growth and profitability.

A) balance of payments

B) parity conditions

C) managed float

D) asset market

Answer: D

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

8) The asset market approach to forecasting assumes that whether foreigners are willing to hold

claims in monetary form depends on an extensive set of investment considerations. These

include all but which of the following choices?

A) relative real interest rates

B) capital market liquidity

C) political safety

D) All of the above are considered by investors in their decision process.

Answer: D

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

9) ________ is defined as the spread of a crisis in one country to its neighboring countries and

other countries with similar characteristics.

A) Speculation

B) Contagion

C) Capital market liquidity

D) Political science

Answer: B

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

10) Critics of the balance of payments approach to exchange rate determination point to the

emphasis on ________ of currency and capital rather than ________ of money or financial

assets.

A) flows; stocks

B) stocks; flows

C) import; export

D) export; import

Answer: A

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

11) Which of the following versions of PPP is thought to be the most relevant to possibly

explaining what drives exchange rate values?

A) The Law of One Price

B) Absolute Purchasing Power Parity

C) Relative Purchasing Power Parity

D) The International Fisher Effect

Answer: C

Diff: 2

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Conceptual

AACSB: Application of knowledge

12) It is safe to say that most determinants of the spot exchange rate are also affected by changes

in the spot rate, i.e., they are linked AND mutually determined.

Answer: TRUE

Diff: 1

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Conceptual

AACSB: Application of knowledge

13) The balance of payments approach of exchange rate theory is largely dismissed by the

academic community today, while the practitioner public still rely on different variations of the

theory for their decision making.

Answer: TRUE

Diff: 1

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

14) Technical analysis of exchange rates developed in part due to the forecasting inadequacies of

fundamental exchange rate theories.

Answer: TRUE

Diff: 1

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Conceptual

AACSB: Application of knowledge

15) The authors claim that theoretical and empirical studies appear to show that fundamentals do

apply to the long-term for foreign exchange.

Answer: TRUE

Diff: 1

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

16) The authors claim that random events, institutional frictions, and technical factors may cause

currency values to deviate significantly from their long-term fundamental path.

Answer: TRUE

Diff: 1

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

17) The asset market approach to forecasting is not applicable to emerging markets.

Answer: FALSE

Diff: 1

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

18) Most theories of technical analysis differentiate fair value from market value.

Answer: TRUE

Diff: 1

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Recognition

AACSB: Application of knowledge

19) Describe the asset market approach to exchange rate determination. How is this consistent

with economic theory of (say, security) prices in general?

Answer: The asset market approach to exchange rate determination looks at relative interest

rates and prospects for economic growth and profitability. This is consistent with the pricing of

equity securities in that the price of a share of stock should reflect expectations about the timing,

magnitude, and risk of future cash flows. In other words, expectations about what is to come is

more important to the price of an asset, including currency prices, than what has occurred in the

past.

Diff: 3

L.O.: 9.1 Exchange Rate Determination: The Theoretical Thread

Skill: Conceptual

AACSB: Application of knowledge

9.2 Currency Market Intervention

1) ________ is the active buying and selling of the domestic currency against foreign currencies.

A) Indirect Intervention

B) Direct Intervention

C) Foreign Direct Investment

D) Federal Funding

Answer: B

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

2) ________ is the alteration of economic or financial fundamentals that are thought to be drivers

of capital to flow in and out of specific currencies.

A) Indirect Intervention

B) Direct Intervention

C) Foreign Direct Investment

D) Capital Controls

Answer: A

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

3) ________ is the restriction of access to foreign currency by government.

A) Indirect Intervention

B) Direct Intervention

C) Foreign Direct Investment

D) Capital Controls

Answer: D

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT a technique used by governments or central banks to impact

domestic currency valuation?

A) Indirect Intervention

B) Direct Intervention

C) Capital Controls

D) All of the above are techniques used to control currency valuation.

Answer: D

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

5) Which of the following is NOT a motivation for a government or central bank to manipulate

domestic currency valuation?

A) fight inflation

B) slow too rapid economic growth

C) spur too slow economic growth

D) All of the above are motivations for the government or central bank to manipulate currency

values.

Answer: D

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

6) If the goal were to decrease the value of a country's currency — to fight an appreciation of the

domestic currency in exchange for foreign currency — the central bank would:

A) buy its own currency in exchange for foreign currency.

B) follow a restrictive monetary policy.

C) drive real rates of interest up.

D) sell its own currency in exchange for foreign currency.

Answer: D

Diff: 2

L.O.: 9.2 Currency Market Intervention

Skill: Conceptual

AACSB: Application of knowledge

7) If the goal were to increase the value of a country's currency — to fight an depreciation of the

domestic currency in exchange for foreign currency — the central bank would:

A) buy its own currency in exchange for foreign currency.

B) follow a expansive monetary policy.

C) drive real rates of interest down.

D) sell its own currency in exchange for foreign currency.

Answer: A

Diff: 2

L.O.: 9.2 Currency Market Intervention

Skill: Conceptual

AACSB: Application of knowledge

8) Slow economic growth and continued unemployment problems are common reasons for

central banks to hold currency values down.

Answer: TRUE

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

9) The fall in the value of the domestic currency will sharply reduce the purchasing power of

foreign tourists in the country whose currency values are falling.

Answer: FALSE

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

10) The International Monetary Fund, as one of its basic principles (Article IV), encourages

members to pursue "currency manipulation" to gain competitive advantages over other members

as opposed to engaging in military action to achieve the same advantage.

Answer: FALSE

Diff: 2

L.O.: 9.2 Currency Market Intervention

Skill: Conceptual

AACSB: Application of knowledge

11) If a central bank wishes to "defend its currency," it might follow an expansive monetary

policy, which would drive real rates of interest up.

Answer: FALSE

Diff: 2

L.O.: 9.2 Currency Market Intervention

Skill: Conceptual

AACSB: Application of knowledge

12) A country wishing for its currency to fall in value, particularly when confronted with a

continual appreciation of its value against major trading partner currencies, the central bank may

work to lower real interest rates, reducing the returns to capital.

Answer: TRUE

Diff: 2

L.O.: 9.2 Currency Market Intervention

Skill: Conceptual

AACSB: Application of knowledge

13) Indirect intervention for domestic currency valuation typically uses tools of monetary policy

as opposed to using tools of fiscal policy.

Answer: TRUE

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

14) Direct intervention for currency valuation involves limiting the ability to exchange domestic

currency for foreign currency.

Answer: FALSE

Diff: 1

L.O.: 9.2 Currency Market Intervention

Skill: Recognition

AACSB: Application of knowledge

15) Explain how a central bank would engage in direct intervention to decrease the value of its

domestic currency. Since the 1970s, it has been difficult for central banks alone to engage in

direct intervention to alter the value of their domestic currency. Identify and explain at least two

other activities in which a central bank could engage to alter the value of their domestic

currency.

Answer: To decrease the value of its domestic currency, a central bank could choose to sell its

own currency, thus making more of its currency available and driving down its value. Because

markets have become so large, it is difficult to effectively move the market in this manner.

Alternative strategies may be to enlist other central banks to make a coordinated effort to sell the

currency into the market, thus putting more currency into play and having a greater negative

impact on its value. Indirect intervention to drive down real interest rates is a second alternative,

and the reduction of capital controls may be able to render a currency less valuable as well.

Diff: 3

L.O.: 9.2 Currency Market Intervention

Skill: Conceptual

AACSB: Application of knowledge

9.3 Disequilibrium: Exchange Rates in Emerging Markets

1) Which of the following was NOT an international currency crisis in the 1990s and early

2000s?

A) the Asian Crisis

B) the Canadian Crisis

C) the Argentine Crisis

D) All of the above were currency crises in the 1990s and 2000s.

Answer: B

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

2) The Asian Currency crisis appeared to begin in:

A) South Korea.

B) Taiwan.

C) Thailand.

D) Japan.

Answer: C

Diff: 2

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

3) The "tequila effect" is a slang term used to describe a form of financial panic called:

A) run on the market.

B) speculation.

C) contrary investing.

D) contagion.

Answer: D

Diff: 2

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

4) Prior to July 2, 1997, the Thai government:

A) allowed the Thai Bhat to float against major currencies.

B) fixed the Bhat's value against the Korean won only.

C) fixed the Bhat's value against major currencies especially the U.S. dollar.

D) none of the above

Answer: C

Diff: 2

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

5) The authors did NOT identify which of the following as a root of the Asian currency crisis?

A) the collapse of some Asian currencies

B) the rate of inflation in the United States

C) corporate socialism

D) banking stability and management

Answer: B

Diff: 3

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Conceptual

AACSB: Application of knowledge

6) The authors refer to the practice of many Asian firms being largely controlled by families of

groups related to the governing body of the country as:

A) illegal.

B) insider trading.

C) cronyism.

D) not in my back yard.

Answer: C

Diff: 2

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

7) The principle focus of the IMF bailout efforts during the Asian financial crisis was:

A) banking liquidity.

B) shareholder's wealth.

C) reestablishing fixed currency exchange rates in Asia.

D) dollarization of Asian currencies.

Answer: A

Diff: 3

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

8) The ________ is the Argentine currency unit.

A) peso

B) dollar

C) real

D) peseta

Answer: A

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

9) A currency board is:

A) a structure, rather than a mere commitment, to limiting the growth of the money supply in the

economy.

B) a recipe for conservative and prudent financial management.

C) designed to eliminate the power of politicians to exercise judgment by relying on an

automatic and unbendable rule.

D) all of the above

Answer: D

Diff: 3

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

10) Argentina's economic performance in the 1990s while their peso was pegged to the U.S.

dollar can be characterized as ________ rates of inflation and ________ rates of unemployment.

A) high; high

B) low; low

C) low; high

D) high; low

Answer: C

Diff: 2

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Conceptual

AACSB: Application of knowledge

11) By 2001, crisis conditions had revealed three very important underlying problems

Argentina's economy EXCEPT:

A) The Argentine peso was overvalued.

B) The currency board regime had eliminated monetary policy alternatives for macroeconomic

policy.

C) The printing of paper money without restrictions, resulting in hyperinflation.

D) The Argentina government budget deficit was out of control - government spending

continued to increased but tax receipts did not.

Answer: C

Diff: 2

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Conceptual

AACSB: Application of knowledge

12) Which of the following did NOT contribute to the Russian currency crisis of 1998?

A) an accelerated flight of capital

B) generally deteriorating economic conditions

C) a surprisingly healthy government surplus that was neither funding internal investment nor

external debt service

D) all of the above

Answer: D

Diff: 2

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

13) In 1991 the Argentine peso was fixed to the value of the U.S. dollar on a one-to-one basis.

Answer: TRUE

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

14) Leading up to the Russian currency collapse of 1998, Russia followed a currency policy of

managed float that allowed their currency to slide daily at a 1.5% per month rate.

Answer: TRUE

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

15) The large and liquid capital and currency markets follow many of the principles outlined by

the different schools of thought on exchange rate determination (parity conditions, balance of

payments approach, and asset approach) relatively well in the medium to long term.

Answer: TRUE

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

16) The smaller and less liquid markets and currency markets frequently demonstrate behaviors

that follow the principles outlined by the different schools of thought on exchange rate

determination (parity conditions, balance of payments approach, and asset approach) relatively

well in the medium to long term.

Answer: FALSE

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

17) The roots of the Asian currency crisis extended from a fundamental change in the economics

of the region, the transition of many Asian nations from being net importers to net exporters.

Answer: FALSE

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

18) The most visible roots of the crisis were in the excesses of capital inflows into Thailand

extending credit to a variety of domestic investments and enterprises beyond what the Thai

economy could support and creating an investment "bubble."

Answer: TRUE

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

19) As economic conditions continued to deteriorate in Argentina by the end of 2001, banks

suffered increasing runs. The government, fearing that the increasing financial drain on banks

would cause their collapse, closed the banks for weeks.

Answer: TRUE

Diff: 1

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Recognition

AACSB: Application of knowledge

20) In 1991, Argentina adopted a currency board (the Argentine peso had been pegged to the

U.S. dollar at a one-to-one rate of exchange) to fight hyperinflation. This currency board lasted

for a decade until the economic crisis of 2001. Discuss: 1) the pros and cons of a currency board

policy, 2) the crisis condition of the Argentina's economy by 2001, and 3) the lessons to be

drawn from the Argentina story.

Answer: Under a currency board, the central bank may increase the money supply in the

banking system only with increases in its holdings of hard currency reserves. By removing the

ability of government to expand the rate of growth of the money supply, Argentina believed it

was eliminating the source of inflation that had devastated its standard of living. It was both a

recipe for conservative and prudent financial management, and a decision to eliminate the power

of politicians, elected and unelected, to exercise judgment both good and bad. It was an

automatic and unbendable rule.

This "cure" was a restrictive monetary policy that slowed economic growth. The country's

unemployment rate rose to double-digit levels in 1994 and stayed there. The real GDP growth

rate settled into recession in late 1998, and the economy continued to shrink through 2000.

Argentine banks allowed depositors to hold their money in either pesos or dollars. This was

intended to provide a market-based discipline to the banking and political systems, and to

demonstrate the government's unwavering commitment to maintaining the peso's value parity

with the dollar. Although intended to build confidence in the system, in the end it proved

disastrous to the Argentine banking system. The 1998 recession proved to be unending. Three-

and-a-half years later, Argentina was still in recession. By 2001, crisis conditions had revealed

three very important underlying problems with Argentina's economy: 1) The Argentine peso was

overvalued; 2) The currency board regime had eliminated monetary policy alternatives for

macroeconomic policy; and 3) The Argentine government budget deficit was out of control.

Inflation had not been eliminated, and the world's markets were watching.

As the unemployment rate grew higher, as poverty and social unrest grew government was faced

with pressure to close the economic and social gaps. Government spending continued to

increase, but tax receipts did not. Argentina turned to the international markets to aid in the

financing of its government's deficit spending. The total foreign debt of the country began rising

dramatically. As economic conditions continued to deteriorate, banks suffered increasing runs.

The government, fearing that the increasing financial drain on banks would cause their collapse,

closed the banks.

On Sunday, January 6, 2002 the peso was devalued from 1.00 Argentine peso per U.S. dollar to

1.40. But the economic pain continued. On February 3, 2002, the Argentine government

announced that the peso would be floated and the government would no longer attempt to fix or

manage its value to any specific level, allowing the market to find or set the exchange rate.

Diff: 3

L.O.: 9.3 Disequilibrium: Exchange Rates in Emerging Markets

Skill: Conceptual

AACSB: Application of knowledge

9.4 Currency Forecasting in Practice

1) ________, traditionally referred to as chartists, focus on price and volume data to determine

past trends that are expected to continue into the future.

A) Mappists

B) Trappist monks

C) Filibusters

D) Technical analysts

Answer: D

Diff: 2

L.O.: 9.4 Currency Forecasting in Practice

Skill: Recognition

AACSB: Application of knowledge

2) Examples of a business motivation for long-run exchange rate forecasts include all but which

of the following?

A) a major capital investment in a foreign country

B) the desire to hedge a 90-day security

C) a portfolio manager considering investing in foreign securities

D) All of the above are examples of a business motivation for long-run exchange rate forecast.

Answer: B

Diff: 3

L.O.: 9.4 Currency Forecasting in Practice

Skill: Recognition

AACSB: Application of knowledge

3) Short-term foreign exchange forecasts are often motivated by such activities as ________

whereas long-term forecasts are more likely motivated by ________.

A) long-term investment; long-term capital appreciation

B) long-term capital appreciation; desire to hedge a receivable

C) the desire to hedge a payable; the desire for long-term investment

D) the desire for long-term investment; the desire to hedge a payable

Answer: C

Diff: 3

L.O.: 9.4 Currency Forecasting in Practice

Skill: Recognition

AACSB: Application of knowledge

4) A major U.S. multinational firm has forecast the euro/dollar rate to be €1.10/$ one year hence,

and an exchange rate of $1.40 for the British pound (£) in the same time period. What does this

imply the company's expected rate for the euro per pound to be in one year?

A) €1.40/£

B) £1.40/€

C) £1.54/€

D) €1.54/£

Answer: D

Diff: 3

L.O.: 9.4 Currency Forecasting in Practice

Skill: Analytical

AACSB: Analytical thinking

5) The longer the time horizon of the technical analyst the more accurate the prediction of

foreign exchange rates is likely to be.

Answer: FALSE

Diff: 1

L.O.: 9.4 Currency Forecasting in Practice

Skill: Conceptual

AACSB: Application of knowledge

6) The single most important element of technical analysis is that future exchange rates are based

on the current exchange rate.

Answer: TRUE

Diff: 2

L.O.: 9.4 Currency Forecasting in Practice

Skill: Recognition

AACSB: Application of knowledge

7) The more efficient the foreign exchange market is, the more likely it is that exchange rate

movements are random walks.

Answer: TRUE

Diff: 1

L.O.: 9.4 Currency Forecasting in Practice

Skill: Conceptual

AACSB: Application of knowledge

8) Technical analysts, traditionally referred to as chartists, focus on fundamental data to

determine past trends that are expected to continue into the future.

Answer: FALSE

Diff: 2

L.O.: 9.4 Currency Forecasting in Practice

Skill: Conceptual

AACSB: Application of knowledge

9) Foreign exchange forecasting can be either long-term, or short-term in duration. Compare and

contrast the motivation for and the techniques a forecaster might use for each of the time periods.

Answer: Short-run forecasts are usually more tactical in nature as a firm may desire to reduce

exchange rate risk associated with foreign receivable or payables. Technical factors and short-

term market expectations are often more important for short-run forecasters than long-run parity

or fundamental economic conditions.

Long-run forecasts are more strategic in nature as firms make key decisions about entering new

foreign markets. Longer time horizons tend to be less accurate but also require less accuracy.

What forecasters typically desire is a general long-run understanding of the relationships

between markets. Fundamental analysis and parity conditions tend to be more important than

technical factors in this type of forecasting.

Diff: 3

L.O.: 9.4 Currency Forecasting in Practice

Skill: Analytical

AACSB: Analytical thinking

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 10 Transaction Exposure

10.1 Types of Foreign Exchange Exposure

1) ________ exposure deals with cash flows that result from existing contractual obligations.

A) Operating

B) Transaction

C) Translation

D) Economic

Answer: B

Diff: 2

L.O.: 10.1 Types of Foreign Exchange Exposure

Skill: Recognition

AACSB: Application of knowledge

2) ________ exposure measures the change in the present value of the firm resulting from

unexpected changes in exchange rates.

A) Operating

B) Transaction

C) Translation

D) Accounting

Answer: A

Diff: 2

L.O.: 10.1 Types of Foreign Exchange Exposure

Skill: Recognition

AACSB: Application of knowledge

3) Each of the following is another name for operating exposure EXCEPT:

A) economic exposure.

B) strategic exposure.

C) accounting exposure.

D) competitive exposure.

Answer: C

Diff: 2

L.O.: 10.1 Types of Foreign Exchange Exposure

Skill: Recognition

AACSB: Application of knowledge

4) Transaction exposure and operating exposure exist because of unexpected changes in future

cash flows. The difference between the two is that ________ exposure deals with cash flows

already contracted for, while ________ exposure deals with future cash flows that might change

because of changes in exchange rates.

A) transaction; operating

B) operating; transaction

C) operating; accounting

D) none of the above

Answer: A

Diff: 2

L.O.: 10.1 Types of Foreign Exchange Exposure

Skill: Recognition

AACSB: Application of knowledge

5) ________ exposure is the potential for accounting-derived changes in owner's equity to occur

because of the need to translate foreign currency financial statements into a single reporting

currency.

A) Transaction

B) Operating

C) Economic

D) Accounting (aka translation)

Answer: D

Diff: 2

L.O.: 10.1 Types of Foreign Exchange Exposure

Skill: Recognition

AACSB: Application of knowledge

6) Losses from ________ exposure generally reduce taxable income in the year they are realized.

________ exposure losses may reduce taxes over a series of years.

A) accounting; Operating

B) operating; Transaction

C) transaction; Operating

D) transaction; Accounting

Answer: C

Diff: 2

L.O.: 10.1 Types of Foreign Exchange Exposure

Skill: Recognition

AACSB: Application of knowledge

7) Losses from ________ exposure generally reduce taxable income in the year they are realized.

________ exposure losses are not cash losses and therefore, are not tax deductible.

A) transaction; Operating

B) accounting; Operating

C) accounting; Transaction

D) transaction; Translation

Answer: D

Diff: 2

L.O.: 10.1 Types of Foreign Exchange Exposure

Skill: Recognition

AACSB: Application of knowledge

10.2 Why Hedge?

1) MNE cash flows may be sensitive to changes in which of the following?

A) exchange rates

B) interest rates

C) commodity prices

D) all of the above

Answer: D

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Recognition

AACSB: Application of knowledge

2) Assuming no transaction costs (i.e., hedging is "free"), hedging currency exposures should

________ the variability of expected cash flows to a firm and at the same time, the expected

value of the cash flows should ________.

A) increase; not change

B) decrease; not change

C) not change; increase

D) not change; not change

Answer: B

Diff: 2

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

3) Which of the following is NOT cited as a good reason for hedging currency exposures?

A) Reduced risk of future cash flows is a good planning tool.

B) Reduced risk of future cash flows reduces the probability that the firm may not meet required

cash flows.

C) Currency risk management increases the expected cash flows to the firm.

D) Management is in a better position to assess firm currency risk than individual investors.

Answer: C

Diff: 2

L.O.: 10.2 Why Hedge?

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is cited as a good reason for NOT hedging currency exposures?

A) Shareholders are more capable of diversifying risk than management.

B) Currency risk management through hedging does not increase expected cash flows.

C) Hedging activities are often of greater benefit to management than to shareholders.

D) All of the above are cited as reasons NOT to hedge.

Answer: D

Diff: 2

L.O.: 10.2 Why Hedge?

Skill: Recognition

AACSB: Application of knowledge

5) A ________ hedge refers to an offsetting operating cash flow such as a payable arising from

the conduct of business.

A) financial

B) natural

C) contractual

D) futures

Answer: B

Diff: 2

L.O.: 10.2 Why Hedge?

Skill: Recognition

AACSB: Application of knowledge

6) As a generalized rule, only realized foreign exchange losses are deductible for tax purposes.

Answer: TRUE

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Recognition

AACSB: Application of knowledge

7) Many MNE s manage foreign exchange exposure centrally, thus gains or losses are always

matched with the country of origin.

Answer: FALSE

Diff: 2

L.O.: 10.2 Why Hedge?

Skill: Recognition

AACSB: Application of knowledge

8) Hedging, or reducing risk, is the same as adding value or return to the firm.

Answer: FALSE

Diff: 2

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

9) There is considerable question among investors and managers about whether hedging is a

good and necessary tool.

Answer: TRUE

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Recognition

AACSB: Application of knowledge

10) The key arguments in opposition to currency hedging such as market efficiency, agency

theory, and diversification do not have financial theory at their core.

Answer: FALSE

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

11) Management often conducts hedging activities that benefit management at the expense of the

shareholders. The field of finance called agency theory frequently argues that management is

generally LESS risk averse than are shareholders.

Answer: FALSE

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

12) Managers CAN outguess the market. If and when markets are in equilibrium with respect to

parity conditions, the expected net present value of hedging should be POSITIVE.

Answer: FALSE

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

13) Shareholders are LESS capable of diversifying currency risk than is the management of the

firm.

Answer: FALSE

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

14) Hedging can be advantageous to shareholders because management is in a better position

than shareholders to recognize disequilibrium conditions and to take advantage of single

opportunities to enhance firm value through selective hedging.

Answer: TRUE

Diff: 1

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

15) Does foreign currency exchange hedging both reduce risk and increase expected value?

Explain, and list several arguments in favor of currency risk management and several against.

Answer: Foreign exchange currency hedging can reduce the variability of foreign currency

receivables or payables by locking in a specific exchange rate in the future via a forward

contract, converting currency at the current spot rate using a money market hedge, or minimizing

unfavorable exchange rate movement with a currency option. None of these hedging techniques,

however, increases the expected value of the foreign currency exchange. In fact, expected value

should fall by an amount equal to the cost of the hedge.

Generally, those in favor of currency risk management find value in the reduction of variability

of uncertain cash flows. Those opposed to currency risk management argue the NPV of such

activities are $0 or less and that shareholders can reduce risk themselves more efficiently. For a

more complete answer to this question, see page 4 where the author outlines several arguments

for and against currency risk management.

Diff: 3

L.O.: 10.2 Why Hedge?

Skill: Conceptual

AACSB: Application of knowledge

10.3 Transaction Exposure

1) The stages in the life of a transaction exposure can be broken into three distinct time periods.

The first time period is the time between quoting a price and reaching an actual sale agreement

or contract. The next time period is the time lag between taking an order and actually filling or

delivering it. Finally, the time it takes to get paid after delivering the product. In order, these

stages of transaction exposure may be identified as:

A) backlog, quotation, and billing exposure.

B) billing, backlog, and quotation exposure.

C) quotation, backlog, and billing exposure.

D) quotation, billing, and backlog exposure.

Answer: C

Diff: 2

L.O.: 10.3 Transaction Exposure

Skill: Recognition

AACSB: Application of knowledge

2) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange

rate is $1.55/£, the account is payable in three months, and the firm chooses to avoid any hedging

techniques designed to reduce or eliminate the risk of changes in the exchange rate. The U.S.

firm is at risk today of a loss if:

A) the exchange rate changes to $1.52/£.

B) the exchange rate changes to $1.58/£.

C) the exchange rate doesn't change.

D) all of the above

Answer: D

Diff: 3

L.O.: 10.3 Transaction Exposure

Skill: Analytical

AACSB: Application of knowledge

3) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange

rate is $1.55/£ , the account is payable in three months, and the firm chooses to avoid any

hedging techniques designed to reduce or eliminate the risk of changes in the exchange rate. If

the exchange rate changes to $1.58/£ the U.S. firm will realize a ________ of ________.

A) loss; $4,500

B) gain; $4,500

C) loss; £4,500

D) gain; £4,500

Answer: B

Diff: 3

L.O.: 10.3 Transaction Exposure

Skill: Analytical

AACSB: Analytical thinking

4) A U.S. firm sells merchandise today to a British company for £150,000. The current exchange

rate is $1.55/£, the account is payable in three months, and the firm chooses to avoid any hedging

techniques designed to reduce or eliminate the risk of changes in the exchange rate. If the

exchange rate changes to $1.52/£ the U.S. firm will realize a ________ of ________.

A) loss; $4,500

B) gain; $4,500

C) loss; £4,500

D) gain; £4,500

Answer: A

Diff: 3

L.O.: 10.3 Transaction Exposure

Skill: Analytical

AACSB: Analytical thinking

5) TRANSACTION exposure measures gains or losses that arise from the settlement of existing

financial obligations whose terms are stated in a foreign currency.

Answer: TRUE

Diff: 1

L.O.: 10.3 Transaction Exposure

Skill: Recognition

AACSB: Application of knowledge

6) Transaction exposure could arise when borrowing or lending funds when repayment is to be

made in the firm's domestic currency.

Answer: FALSE

Diff: 1

L.O.: 10.3 Transaction Exposure

Skill: Recognition

AACSB: Application of knowledge

10.4 Transaction Exposure Management

1) ________ is NOT a commonly used contractual hedge against foreign exchange transaction

exposure.

A) Forward market hedge

B) Money market hedge

C) Options market hedge

D) All of the above are contractual hedges.

Answer: D

Diff: 2

L.O.: 10.4 Transaction Exposure Management

Skill: Recognition

AACSB: Application of knowledge

Instruction 10.1:

Use the information for the following problem(s).

Central Valley Transit Inc. (CVT) has just signed a contract to purchase light rail cars from a

manufacturer in Germany for €3,000,000. The purchase was made in June with payment due six

months later in December. Because this is a sizable contract for the firm and because the contract

is in euros rather than dollars, CVT is considering several hedging alternatives to reduce the

exchange rate risk arising from the sale. To help the firm make a hedging decision you have

gathered the following information.

• The spot exchange rate is $1.250/euro

• The six-month forward rate is $1.22/euro

• CVT's cost of capital is 11%

• The Euro zone 6-month borrowing rate is 9% (or 4.5% for 6 months)

• The Euro zone 6-month lending rate is 7% (or 3.5% for 6 months)

• The U.S. 6-month borrowing rate is 8% (or 4% for 6 months)

• The U.S. 6-month lending rate is 6% (or 3% for 6 months)

• December call options for euro 750,000; strike price $1.28, premium price is 1.5%

• CVT's forecast for 6-month spot rates is $1.27/euro

• The budget rate, or the highest acceptable purchase price for this project, is $3,900,000 or

$1.30/euro

2) Refer to Instruction 10.1. If CVT chooses NOT to hedge their euro payable, the amount they

pay in six months will be:

A) $3,500,000.

B) $3,900,000.

C) €3,000,000.

D) unknown today

Answer: D

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

3) Refer to Instruction 10.1. If CVT chooses to hedge its transaction exposure in the forward

market, it will ________ €3,000,000 forward at a rate of ________.

A) buy; $1.22

B) buy; $1.25

C) sell; $1.22

D) sell; €1.25

Answer: A

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

4) Refer to Instruction 10.1. CVT chooses to hedge its transaction exposure in the forward

market at the available forward rate. The required amount in dollars to pay off the accounts

payable in 6 months will be:

A) $3,000,000.

B) $3,660,000.

C) $3,750,000.

D) $3,810,000.

Answer: B

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

5) Refer to Instruction 10.1. If CVT locks in the forward hedge at $1.22/euro, and the spot rate

when the transaction was recorded on the books was $1.25/euro, this will result in a "foreign

exchange accounting transaction ________ of ________.

A) loss; $90,000

B) loss; €90,000

C) gain; $90,000

D) gain; €90,000

Answer: C

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

6) Refer to Instruction 10.1. CVT would be ________ by an amount equal to ________ with a

forward hedge than if they had NOT hedged and their predicted exchange rate for 6 months had

been correct.

A) better off; $150,000

B) better off; €150,000

C) worse off; $150,000

D) worse off; €150,000

Answer: A

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

7) Refer to Instruction 10.1. What is the cost of a call option hedge for CVT's euro receivable

contract? (Note: Calculate the cost in future value dollars and assume the firm's cost of capital as

the appropriate interest rate for calculating future values.)

A) $57,600

B) $59,904

C) $62,208

D) $63,936

Answer: B

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

8) Refer to Instruction 10.1. The cost of a put option to CVT would be:

A) $52,500.

B) $55,388.

C) $58,275.

D) There is not enough information to answer this question.

Answer: D

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

9) When attempting to manage an account payable denominated in a foreign currency, the firm's

only choice is to remain unhedged.

Answer: FALSE

Diff: 1

L.O.: 10.4 Transaction Exposure Management

Skill: Recognition

AACSB: Application of knowledge

10) Remaining unhedged is NOT an option when dealing with foreign exchange transaction

exposure.

Answer: FALSE

Diff: 1

L.O.: 10.4 Transaction Exposure Management

Skill: Recognition

AACSB: Application of knowledge

11) A forward hedge involves a put or call option contract and a source of funds to fulfill that

contract.

Answer: FALSE

Diff: 1

L.O.: 10.4 Transaction Exposure Management

Skill: Recognition

AACSB: Application of knowledge

12) Like a forward market hedge, a money market hedge also involves a contract and a source of

funds to fulfill that contract. In this instance, the contract is a loan agreement.

Answer: TRUE

Diff: 1

L.O.: 10.4 Transaction Exposure Management

Skill: Recognition

AACSB: Application of knowledge

13) Hedging transaction exposure with option contracts allows the firm to benefit if exchange

rates are favorable but protects the firm if exchange rates turn unfavorable.

Answer: TRUE

Diff: 1

L.O.: 10.4 Transaction Exposure Management

Skill: Recognition

AACSB: Application of knowledge

14) A firm's risk tolerance is a combination of management's philosophy toward transaction

exposure and the specific goals of treasury activities.

Answer: TRUE

Diff: 1

L.O.: 10.4 Transaction Exposure Management

Skill: Recognition

AACSB: Application of knowledge

15) The structure of a money market hedge is similar to a forward hedge. The difference is the

cost of the money market hedge is determined by the differential interest rates, while the forward

hedge is a function of the forward rates quotation.

Answer: TRUE

Diff: 2

L.O.: 10.4 Transaction Exposure Management

Skill: Conceptual

AACSB: Application of knowledge

16) In efficient markets, interest rate parity should assure that the costs of a forward hedge and

money market hedge should be approximately the same.

Answer: TRUE

Diff: 1

L.O.: 10.4 Transaction Exposure Management

Skill: Conceptual

AACSB: Application of knowledge

17) Currency risk management techniques include forward hedges, money market hedges, and

option hedges. Draw a diagram showing the possible outcomes of these hedging alternatives for

a foreign currency receivable contract. In your diagram, be sure to label the X and Y-axis, the put

option strike price, and show the possible results for a money market hedge, a forward hedge, a

put option hedge, and an uncovered position. (Note: Assume the forward currency receivable is

British pounds and the put option strike price is $1.50/£, the price of the option is $0.04 the

forward rate is $1.52/£ and the current spot rate is $1.48/£.)

Answer: The student should draw and label a diagram that looks similar to the one found in

Exhibit 10.5.

Diff: 3

L.O.: 10.4 Transaction Exposure Management

Skill: Analytical

AACSB: Analytical thinking

10.5 Transaction Exposure Management in Practice

1) ________ are transactions for which there are, at present, no contracts or agreements between

parties.

A) Backlog exposure

B) Quotation exposure

C) Anticipated exposure

D) none of the above

Answer: C

Diff: 2

L.O.: 10.5 Transaction Exposure Management in Practice

Skill: Recognition

AACSB: Application of knowledge

2) According to a survey by Bank of America, the type of foreign exchange risk most often

hedged by firms is:

A) translation exposure.

B) transaction exposure.

C) contingent exposure.

D) economic exposure.

Answer: B

Diff: 2

L.O.: 10.5 Transaction Exposure Management in Practice

Skill: Recognition

AACSB: Application of knowledge

3) The treasury function of most firms, the group typically responsible for transaction exposure

management, is NOT usually considered a profit center.

Answer: TRUE

Diff: 1

L.O.: 10.5 Transaction Exposure Management in Practice

Skill: Recognition

AACSB: Application of knowledge

4) According to the authors, firms that employ proportional hedges increase the percentage of

forward-cover as the maturity of the exposure lengthens.

Answer: FALSE

Diff: 1

L.O.: 10.5 Transaction Exposure Management in Practice

Skill: Recognition

AACSB: Application of knowledge

5) Although rarely acknowledged by the firms themselves, selective hedging is essentially

speculation.

Answer: TRUE

Diff: 1

L.O.: 10.5 Transaction Exposure Management in Practice

Skill: Recognition

AACSB: Application of knowledge

6) There are as many different approaches to foreign exchange transaction exposure management

as there are firms and no real consensus exists regarding the best approach. List and discuss three

different exposures you can hedge and three different types of hedges (for example option

hedges versus non-option hedges).

Answer: Foreign exchange exposure is a measure of the potential for a firm's profitability, net

cash flow, and market value to change because of a change in exchange rates. There are two

distinct categories of foreign exchange exposure for the firm: 1) Accounting exposure

(transaction exposure and translation exposure) arises from contracts and accounts being

denominated in foreign currency, 2) Economic exposure is the potential change in the value of

the firm from its changing global competitiveness as determined by exchange rates.

A transaction exposure is created at the first moment the seller quotes a price in foreign currency

terms to a potential buyer (quotation exposure). When the order is placed, the potential exposure

created at the time of the quotation is converted into actual exposure, called backlog exposure,

because the product has not yet been shipped or billed. Backlog exposure lasts until the goods

are shipped and billed, at which time it becomes billing exposure. Billing exposure remains until

payment is received by the seller.

Transaction exposure management programs are generally divided along an "option-line," those

that use options (calls and puts) and those that do not (forward/futures contracts and money

market hedges).

Diff: 2

L.O.: 10.5 Transaction Exposure Management in Practice

Skill: Conceptual

AACSB: Application of knowledge

7) Many MNEs have established rigid transaction exposure risk management policies which

mandate proportional hedging (a percentage of existing transaction exposures). Explain the pros

and cons of proportional hedging.

Answer: First of all, hedging is expensive. These policies generally require the use of forward

contract hedges on a percentage (e.g., 50, 60, or 70%) of existing transaction exposures. As the

maturity of the exposures lengthens, the percentage forward-cover required decreases. The

remaining portion of the exposure is then selectively hedged on the basis of the firm's risk

tolerance, view of exchange rate movements, and confidence level. Although rarely

acknowledged by the firms themselves, selective hedging is essentially speculation. A significant

question remains as to whether a firm or a financial manager can consistently predict the future

direction of exchange rates.

Diff: 2

L.O.: 10.5 Transaction Exposure Management in Practice

Skill: Conceptual

AACSB: Application of knowledge

Appendix B — The Optimal Hedge Ratio and Hedge Effectiveness

1) When there is a full forward cover with the spot rate equal to the forward rate all of the

following are true EXCEPT:

A) The hedge is asymmetric.

B) There is no uncovered exposure remaining.

C) The total position is a perfect hedge.

D) The currency hedge ratio is equal to 1.

Answer: A

Diff: 3

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

2) The objective of currency hedging is to eliminate the change in the value of the exposed asset

or cash flow from a change in exchange rates.

Answer: FALSE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

3) Hedging is accomplished by combining the exposed asset with a hedge asset to create a two-

asset portfolio in which the two assets react in relatively equal directions to an exchange rate

change.

Answer: FALSE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

4) With the use of forwards, a perfect hedge is possible.

Answer: TRUE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

5) With a perfect hedge, there is no uncovered exposure remaining.

Answer: TRUE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

6) A hedge constructed using puts foreign currency options would be symmetric.

Answer: FALSE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

7) The commonly used 100% forward contract cover is a symmetric hedge.

Answer: TRUE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

8) The effectiveness of a hedge is determined to what degree the change in spot asset's value is

correlated with the equal change in the hedge asset's value to a change in the underlying spot

exchange rate.

Answer: FALSE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

9) The hedge ratio, β, is an individual exposure's nominal amount covered by a financial

instrument such as a forward contract or currency option.

Answer: FALSE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

10) A hedge constructed using a put foreign currency option would protect you against value

losses, but allow, at the same time, the possibly reap value increases in the event the exchange

rate moved in your favor.

Answer: TRUE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

11) The various hedging alternatives explored (the forward, money market, and purchase option

hedges) only work to protect the value of the exposed asset at the time of maturity.

Answer: FALSE

Diff: 1

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

12) There are as many different approaches to exposure management as there are firms and no

real consensus exists regarding the best approach. Discuss the following theoretical dimensions

to currency hedging: optimal hedge ratio, hedge symmetry, hedge effectiveness and hedge

timing.

Answer: The objective of currency hedging is to minimize the change in the value of the

exposed asset or cash flow from a change in exchange rates. Hedging is accomplished by

combining the exposed asset with a hedge asset to create a two-asset portfolio in which the two

assets react in relatively equal but opposite directions to an exchange rate change. If the entire

exposure was covered, that is a hedge ratio of 1.0 or 100%. The hedge ratio, β, is the percentage

of an individual exposure's nominal amount covered by a financial instrument such as a forward

contract or currency option.

Some hedges can be constructed to result in no change in value to any and all exchange rate

changes. The hedge is constructed so that whatever spot value is lost (or gained) as a result of

aderse (or faorale) exchane rate moements ( pot), that alue is replaced  an equal ut

opposite chane in the alue of the hede asset, ( ede). The 1 forward contract cover is

symmetrical hedge.

The effectiveness of a hedge is determined to what degree the change in spot asset's value is

correlated with the equal but opposite change in the hedge asset's value to a change in the

underlying spot exchange rate. The less than perfect correlation is termed basis risk.

The hedger must also determine the timing of the hedge objective. The hedger can protect the

value of the exposed asset only at the time of its maturity or settlement, or at various points in

time over the life of the exposure.

Diff: 2

L.O.: Appendix B - The Optimal Hedge Ratio and Hedge Effectiveness

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 11 Translation Exposure

11.1 Overview of Translation

1) Translation exposure may also be called ________ exposure.

A) transaction

B) operating

C) accounting

D) currency

Answer: C

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

2) ________ exposure is the potential for an increase or decrease in the parent company's net

worth and reported net income caused by a change in exchange rates since the last transaction.

A) Transaction

B) Operating

C) Currency

D) Translation

Answer: D

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

3) Translation exposure measures:

A) changes in the value of outstanding financial obligations incurred prior to a change in

exchange rates.

B) the potential for an increase or decrease in the parent company's net worth and reported net

income caused by a change in exchange rates since the last consolidation of international

operations.

C) an unexpected change in exchange rates impact on short run expected cash flows.

D) none of the above

Answer: B

Diff: 2

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

4) According to your authors, the main purpose of translation is:

A) to prepare consolidated financial statements.

B) to help management assess the performance of foreign subsidiaries.

C) to act as an interpreter for managers without foreign language skills.

D) none of the above

Answer: A

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

5) Historical exchange rates may be used for ________, while current exchange rates may be

used for ________.

A) fixed assets and current assets; income and expense items

B) equity accounts and fixed assets; current assets and liabilities

C) current assets and liabilities; equity accounts and fixed assets

D) equity accounts and current liabilities; current assets and fixed assets

Answer: B

Diff: 2

L.O.: 11.1 Overview of Translation

Skill: Conceptual

AACSB: Application of knowledge

6) If an imbalance results from the accounting method used for translation, the imbalance is

taken either to ________ or ________.

A) the bank; the post office

B) depreciation; the market for foreign exchange swaps

C) current income; equity reserves

D) current liabilities; equity reserves

Answer: C

Diff: 2

L.O.: 11.1 Overview of Translation

Skill: Conceptual

AACSB: Application of knowledge

7) Generally speaking, translation methods by country define the translation process as a

function of what two factors?

A) size; location

B) a firm's functional currency; location

C) location; foreign subsidiary independence

D) foreign subsidiary independence; a firm's functional currency

Answer: D

Diff: 2

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

8) A/An ________ subsidiary is one in which the firm operates as an extension of the parent

company with cash flows highly interrelated with the parent.

A) self-sustaining foreign

B) integrated foreign entity

C) foreign

D) none of the above

Answer: B

Diff: 2

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

9) Consider two different foreign subsidiaries of Georgia-Pacific Wood Products Inc. The first

subsidiary mills trees in Canada and ships its entire product to the Georgia-Pacific U.S. The

second subsidiary is also owned by the parent firm but is located in Japan and retails tropical

hardwood furniture that it buys from many different sources. The first subsidiary is likely a/an

________ foreign entity with most of its cash flows in U.S. dollars, and the second subsidiary is

more of a/an ________ foreign entity.

A) domestic; integrated

B) self-sustaining; domestic

C) integrated; self-sustaining

D) self-sustaining; integrated

Answer: C

Diff: 2

L.O.: 11.1 Overview of Translation

Skill: Conceptual

AACSB: Application of knowledge

10) A foreign subsidiary's ________ currency is the currency used in the firm's day-to-day

operations.

A) local

B) integrated

C) notational dollar

D) functional

Answer: D

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

11) The ________ determines accounting policy for U.S. firms.

A) Securities and Exchange Commission (SEC)

B) Federal Reserve System (Fed)

C) Financial Accounting Standards Board (FASB)

D) General Agreement on Tariffs and Trade (GATT)

Answer: C

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

12) It is possible to use different exchange rates for different line items on a financial statement.

Answer: TRUE

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Conceptual

AACSB: Application of knowledge

13) If the same exchange rate were used to remeasure every line on a financial statement, then

there would be no imbalances from remeasuring.

Answer: TRUE

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Conceptual

AACSB: Application of knowledge

14) A foreign subsidiary's functional currency is the currency of the primary economic

environment in which the subsidiary operates and in which it generates cash flows.

Answer: TRUE

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Conceptual

AACSB: Application of knowledge

15) It is highly unusual for a multinational firm to have both integrated foreign entities AND

self-sustaining foreign entities.

Answer: FALSE

Diff: 1

L.O.: 11.1 Overview of Translation

Skill: Recognition

AACSB: Application of knowledge

16) Most countries specify the translation method to be used by a foreign subsidiary based on its

business operations or the functional currency. Explain both subsidiary characterization criteria

and the one adopted in the United States.

Answer: A foreign subsidiary's business can be categorized as either an integrated foreign entity

or a self-sustaining foreign entity. An integrated foreign entity is one that operates as an

extension of the parent company, with cash flows and general business lines that are highly

interrelated with those of the parent. A self-sustaining foreign entity is one that operates in the

local economic environment independent of the parent company. The differentiation is important

to the logic of translation. A foreign subsidiary should be valued principally in terms of the

currency that is the basis of its economic viability. It is not unusual for a single company to have

both types of foreign subsidiaries, integrated and self-sustaining.

A foreign subsidiary's functional currency is the currency of the primary economic environment

in which the subsidiary operates and in which it generates cash flows. In other words, it is the

dominant currency used by that foreign subsidiary in its day-to-day operations. It is important to

note that the geographic location of a foreign subsidiary and its functional currency may be

different.

The United States, rather than distinguishing a foreign subsidiary as either integrated or self-

sustaining, requires that the functional currency of the subsidiary be determined. Management

must evaluate the nature and purpose of each of its individual foreign subsidiaries to determine

the appropriate functional currency for each. If a foreign subsidiary of a U.S.-based company is

determined to have the U.S. dollar as its functional currency, it is essentially an extension of the

parent company (equivalent to the integrated foreign entity designation used by most countries).

If, however, the functional currency of the foreign subsidiary is determined to be different from

the U.S. dollar, the subsidiary is considered a separate entity from the parent (equivalent to the

self-sustaining entity designation).

Diff: 2

L.O.: 11.1 Overview of Translation

Skill: Conceptual

AACSB: Application of knowledge

11.2 Translation Methods

1) The two basic methods for the translation of foreign subsidiary financial statements are the

________ method and the ________ method.

A) current rate; temporal

B) temporal; proper timing

C) current rate; future rate

D) none of the above

Answer: A

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

2) Gains or losses caused by translation adjustments when using the current rate method are

reported separately on the:

A) consolidated statement of cash flow.

B) consolidated income statement.

C) consolidated balance sheet.

D) none of the above

Answer: C

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

3) The basic advantage of the ________ method of foreign currency translation is that foreign

nonmonetary assets are carried at their original cost in the parent's consolidated statement while

the most important advantage of the ________ method is that the gain or loss from translation

does not pass through the income statement.

A) monetary; current rate

B) temporal; current rate

C) temporal; monetary

D) current rate; temporal

Answer: D

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Conceptual

AACSB: Application of knowledge

4) Under the U.S. method of translation procedures, if the financial statements of the foreign

subsidiary of a U.S. company are maintained in U.S. dollars:

A) translation is accomplished through the current rate method.

B) translation is accomplished through the temporal method.

C) translation is not required.

D) the translation method to be used is not obvious.

Answer: C

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Conceptual

AACSB: Application of knowledge

5) Under the U.S. method of translation procedures, if the financial statements of the foreign

subsidiary of a U.S. company are maintained in the local currency, and the local currency is the

functional currency, then:

A) the translation method to be used is not obvious.

B) translation is accomplished through the temporal method.

C) translation is not required.

D) translation is accomplished through the current rate method.

Answer: D

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Conceptual

AACSB: Application of knowledge

6) Under the U.S. method of translation procedures, if the financial statements of the foreign

subsidiary of a U.S. company are maintained in the local currency, and the U.S. dollar is the

functional currency, then:

A) translation is not required.

B) translation is accomplished through the current rate method.

C) translation is accomplished through the temporal method.

D) none of the above

Answer: C

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Conceptual

AACSB: Application of knowledge

7) Under U.S. accounting and translation practices, use of the current rate method is termed

________ while use of the temporal method is termed ________.

A) translation; the same

B) translation; remeasurement

C) remeasurement; the same

D) remeasurement; translation

Answer: B

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

8) Which of the following primary principles of U.S. translation procedures is NOT true?

A) If the financial statements of the foreign subsidiary of a U.S. company are maintained in U.S.

dollars, translation is not required.

B) If the financial statements of the foreign subsidiary are maintained in the local currency and

the local currency is the functional currency, they are translated by the temporal method.

C) If the financial statements of the foreign subsidiary are maintained in the local currency and

the U.S. dollar is the functional currency, they are remeasured by the temporal method.

D) All of the above are true.

Answer: B

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

9) ________ occur as a result of changes in the value of currency, whereas ________ occur as a

result of ongoing business activities.

A) Operating gains or losses; translation gains or losses

B) Swap losses; translation gains or losses

C) Translation gains or losses; operating gains or losses

D) all of the above

Answer: C

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

10) Exchange rate imbalances that are passed through the balance sheet affect a firm's reported

income, but imbalances transferred to the income statement do not.

Answer: FALSE

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

11) The current rate method is the most prevalent method today for the translation of financial

statements.

Answer: TRUE

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

12) The temporal rate method is the most prevalent method today for the translation of financial

statements.

Answer: FALSE

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

13) The biggest advantage of the current rate method of reporting translation adjustments is the

fact that the gain or loss goes directly to the reserve account on the consolidated balance sheet

and does not pass through the consolidated income statement.

Answer: TRUE

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

14) Under the temporal rate method, specific assets and liabilities are translated at exchange rates

consistent with the timing of the item's creation.

Answer: TRUE

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

15) The temporal method of foreign currency translation gains or losses resulting from

remeasurement are carried directly to current consolidated income and thus introduces volatility

to consolidated earnings.

Answer: TRUE

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

16) The current rate method and the temporal method are two basic methods for translation that

are employed worldwide.

Answer: TRUE

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

17) Under U.S. accounting and translation practices, use of the current rate method is termed

"translation" while use of the temporal method is termed "remeasurement."

Answer: TRUE

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

18) If the financial statements of the foreign subsidiary are maintained in the local currency and

the U.S. dollar is the functional currency, they are remeasured by the temporal method.

Answer: TRUE

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

19) Translation gains or losses can be quite different from operating gains or losses not only in

magnitude but also in sign.

Answer: TRUE

Diff: 1

L.O.: 11.2 Translation Methods

Skill: Recognition

AACSB: Application of knowledge

20) The two methods for the translation of foreign subsidiary financial statements are the current

rate and temporal methods. Briefly, describe how each of these methods translates the foreign

subsidiary financial statements into the parent company's consolidated statements. Identify when

each technique should be used and the major advantage(s) of each.

Answer: The current rate method translates almost all line items from the foreign subsidiary to

the parent consolidated statements at the current exchange rate. This is the most commonly used

method in the world today. Assets and liabilities are translated at current exchange rate and items

found on the income statement are translated at the actual exchange rate on the date of

transaction, or as an average over the statement period where appropriate. Equity accounts are

translated at historical costs.

Any gains or losses caused by translation adjustments are typically placed into a special reserve

account (such as a CTA). Thus, gains or losses do not go through the income statement and do

not increase the volatility of net income. This is perhaps the biggest advantage to using the

current rate method.

By contrast, the temporal method assumes that several individual financial statement items are

periodically restated to reflect their market value. The temporal method translates individual line

items based on monetary/nonmonetary criteria where monetary assets such as cash and

marketable securities are translated at current exchange rates, but nonmonetary assets such as

fixed assets are translated at historical rates. The gains or losses that result from translation

remeasurement are recorded on the consolidated income statement and impact upon the volatility

of net income. The temporal method of using historical costs may be more consistent with the

practice of carrying domestic items at cost on the financial statements.

Diff: 2

L.O.: 11.2 Translation Methods

Skill: Conceptual

AACSB: Application of knowledge

11.3 Ganado Corporation's Translation Exposure

1) If the European subsidiary of a U.S. firm has net exposed assets of €750,000, and the euro

drops in value from $1.30/euro to $1.20/€ the U.S. firm has a translation:

A) gain of $75,000.

B) loss of $75,000.

C) gain of $625,000.

D) loss of €576,923.

Answer: B

Diff: 3

L.O.: 11.3 Ganado Corporation's Translation Exposure

Skill: Analytical

AACSB: Analytical thinking

2) If the European subsidiary of a U.S. firm has net exposed assets of €200,000, and the euro

increases in value from $1.22/€ to $1.26/€ the U.S. firm has a translation:

A) gain of $8,000.

B) loss of $8,000.

C) gain of $252,000.

D) loss of €252,000.

Answer: A

Diff: 3

L.O.: 11.3 Ganado Corporation's Translation Exposure

Skill: Analytical

AACSB: Analytical thinking

3) If the British subsidiary of a European firm has net exposed assets of £125,000, and the pound

increases in value from €1.40/£ to €1.44/£, the European firm has a translation:

A) loss of €5,000.

B) gain of €5,000.

C) gain of £5,000.

D) loss of £5,000.

Answer: B

Diff: 3

L.O.: 11.3 Ganado Corporation's Translation Exposure

Skill: Analytical

AACSB: Analytical thinking

4) If the British subsidiary of a European firm has net exposed assets of £250,000, and the pound

drops in value from €1.35/£ to €1.30/£, the European firm has a translation:

A) gain of €12,500.

B) loss of €12,500.

C) loss of £12,500.

D) gain of £12,500.

Answer: B

Diff: 3

L.O.: 11.3 Ganado Corporation's Translation Exposure

Skill: Analytical

AACSB: Analytical thinking

5) The value contribution of a subsidiary of a multinational firm to the firm can be reported in

the income statement or balance sheet of the consolidated firm. Explain the reporting of the

changes in the value of a subsidiary as a result of the change in an exchange rate — changes to

the income and the assets of the subsidiary — in the consolidated financial statements of the

parent company.

Answer: The earnings of the subsidiary, once remeasured into the home currency of the parent

company, contributes directly to the consolidated income of the firm. An exchange rate change

results in fluctuations in the value of the subsidiary's income to the global corporation. If the

individual subsidiary in question constitutes a relatively significant or material component of

consolidated income, the multinational firm's reported income (and earnings per share, EPS) may

be seen to change purely as a result of translation.

Changes in the reporting currency value of the net assets of the subsidiary are passed into

consolidated income or equity. If the foreign subsidiary was designated as "dollar functional,"

remeasurement results in a transaction exposure, which is passed through current consolidated

income. If the foreign subsidiary was designated as "local currency functional," translation

results in a translation adjustment and is reported in consolidated equity as a translation

adjustment. It does not alter reported consolidated net income.

Diff: 2

L.O.: 11.3 Ganado Corporation's Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

11.4 Managing Translation Exposure

1) The main technique to minimize translation exposure is called a/an ________ hedge.

A) balance sheet

B) income statement

C) forward

D) translation

Answer: A

Diff: 1

L.O.: 11.4 Managing Translation Exposure

Skill: Recognition

AACSB: Application of knowledge

2) A balance sheet hedge requires that the amount of exposed foreign currency assets and

liabilities:

A) have a 2:1 ratio of assets to liabilities.

B) have a 2:1 ratio of liabilities to assets.

C) have a 2:1 ratio of liabilities to equity.

D) be equal.

Answer: D

Diff: 1

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

3) If a firm's balance sheet has an equal amount of exposed foreign currency assets and liabilities

and the firm translates by the temporal method, then:

A) the net exposed position is called monetary balance.

B) the change is value of liabilities and assets due to a change in exchange rates will be of equal

but opposite direction.

C) Both A and B are true.

D) none of the above

Answer: C

Diff: 2

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

4) If a firm's subsidiary is using the local currency as the functional currency, which of the

following is NOT a circumstance that could justify the use of a balance sheet hedge?

A) The foreign subsidiary is about to be liquidated, so that the value of its Cumulative

Translation Adjustment (CTA) would be realized.

B) The firm has debt covenants or bank agreements that state the firm's debt/equity ratio will be

maintained within specific limits.

C) The foreign subsidiary is operating is a hyperinflationary environment.

D) All of the above are appropriate reasons to use a balance sheet hedge.

Answer: D

Diff: 2

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

5) If the parent firm and all subsidiaries denominate all exposed assets and liabilities in the

parent's reporting currency this will ________ exposure but each subsidiary would have

________ exposure.

A) maximize translation; no transaction

B) eliminate translation; transaction

C) maximize transaction; no translation

D) eliminate transaction; translation

Answer: B

Diff: 2

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

6) A Canadian subsidiary of a U.S. parent firm is instructed to bill an export to the parent in U.S.

dollars. The Canadian subsidiary records the accounts receivable in Canadian dollars and notes a

profit on the sale of goods. Later, when the U.S. parent pays the subsidiary the contracted U.S.

dollar amount, the Canadian dollar has appreciated 10% against the U.S. dollar. In this example,

the Canadian subsidiary will record a:

A) 10% foreign exchange loss on the U.S. dollar accounts receivable.

B) 10% foreign exchange gain on the U.S. dollar accounts receivable.

C) Since the Canadian firm is a U.S. subsidiary, neither a gain nor loss will be recorded.

D) Any gain or loss will be recorded only by the parent firm.

Answer: A

Diff: 2

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

7) ________ gains and losses are "realized" whereas ________ gains and losses are only "paper."

A) Translation; transaction

B) Transaction; translation

C) Translation; operating

D) none of the above

Answer: B

Diff: 2

L.O.: 11.4 Managing Translation Exposure

Skill: Recognition

AACSB: Application of knowledge

8) It is possible that efforts to decrease translation exposure may result in an increase in

transaction exposure.

Answer: TRUE

Diff: 1

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

9) One possible reason for a balance sheet hedge could be because the foreign subsidiary is about

to be liquidated, so that value of its Cumulative Translation Adjustment (CTA) would be

realized.

Answer: TRUE

Diff: 1

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

10) One possible reason for a balance sheet hedge could be because the firm has debt covenants

or bank agreements that state the firm's debt/equity ratios will be maintained within specific

limits.

Answer: TRUE

Diff: 1

L.O.: 11.4 Managing Translation Exposure

Skill: Recognition

AACSB: Application of knowledge

11) If management expects a foreign currency to depreciate, it could minimize translation

exposure by increasing net exposed assets.

Answer: FALSE

Diff: 1

L.O.: 11.4 Managing Translation Exposure

Skill: Recognition

AACSB: Application of knowledge

12) If management anticipates an appreciation of the foreign currency, it should decrease net

exposed assets to benefit from a gain.

Answer: FALSE

Diff: 1

L.O.: 11.4 Managing Translation Exposure

Skill: Recognition

AACSB: Application of knowledge

13) Describe a balance sheet hedge and give at least two examples of when such a hedge could

be justified.

Answer: A balance sheet hedge attempts to equalize the amount of assets and liabilities of a

foreign subsidiary exposed to translation risk. Thus, the gain to the firm from a change in

exchange rates will be perfectly offset by an equal and opposite loss. Firms may engage in

balance sheet hedges under conditions of hyperinflation, or when the subsidiary is about to be

liquidated and the value of the CTA account would be realized. The author on page 16 lists other

examples.

Diff: 3

L.O.: 11.4 Managing Translation Exposure

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 12 Operating Exposure

12.1 A Multinational's Operating Exposure

1) Another name for operating exposure is ________ exposure.

A) economic

B) competitive

C) strategic

D) all of the above

Answer: D

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

2) What type of international risk exposure measures the change in present value of a firm

resulting from changes in future operating cash flows caused by any unexpected change in

exchange rates?

A) transaction exposure

B) accounting exposure

C) operating exposure

D) translation exposure

Answer: C

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

3) ________ cash flows arise from intracompany and intercompany receivables and payments,

while ________ cash flows are payments for the use of loans and equity.

A) Financing; operating

B) Operating; financing

C) Operating; accounting

D) Accounting; financing

Answer: B

Diff: 2

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT an example of a financial cash flow?

A) parent invested equity capital

B) interest on intrafirm lending

C) payment for goods and services

D) intrafirm principal payments

Answer: C

Diff: 2

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

5) Which of the following is NOT an example of an operating cash flow?

A) management fees and distributed overhead

B) royalties and license fees

C) rent and lease payments

D) dividend paid to parent company

Answer: D

Diff: 2

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

6) ________ exposure is far more important for the long-run health of a business than changes

caused by ________ or ________ exposure.

A) Operating; translation; transaction

B) Transaction; operating; translation

C) Accounting; translation; transaction

D) Translation; operating; transaction

Answer: A

Diff: 2

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

7) Simpson Sign Company based in Frostbite Falls, Minnesota has a 6-month C$100,000

contract to complete sign work in Winnipeg, Manitoba, Canada. The current spot rate is

$1.02/C$ and the forward rate is $1.01/C$. Under conditions of equilibrium, management would

use ________ today when preparing operating budgets.

A) $102,000

B) $101,000

C) $100,000

D) none of the above

Answer: B

Diff: 3

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Analytical

AACSB: Analytical thinking

8) When considering the phases of adjustment and response to operating exposure in the LONG

RUN, price changes tend to be ________ and volume changes tend to be ________.

A) fixed/contracted; contracted.

B) fixed/contracted; completely flexible.

C) completely flexible; completely flexible.

D) completely flexible; contracted.

Answer: C

Diff: 2

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

9) The goal of operating exposure analysis is to identify strategic operating techniques the firm

might adopt to enhance value in the face of unanticipated exchange rate changes.

Answer: TRUE

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

10) Operating cash flows may occur in different currencies and at different times, but financing

cash flows may occur only in a single currency.

Answer: FALSE

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

11) Expected changes in foreign exchange rates should already be factored into anticipated

operating results by management and investors.

Answer: TRUE

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

12) Even though contracts are often fixed in the short run, as time passes, prices and costs can be

changed to reflect the new competitive realities caused by a change in exchange rates.

Answer: TRUE

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

13) The higher the price elasticity of demand, the higher the degree of pass-through.

Answer: FALSE

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

14) An unexpected change in exchange rates impacts a firm's expected cash flows at three levels,

depending on the time horizon used (Short Run, Medium Run, and Long Run). Describe the

three operating exposure's phases of adjustment assuming that parity conditions do not hold

among foreign exchange rates, national inflation rates, and national interest rates

(disequilibrium).

Answer: The first level impact is on expected cash flows in the one-year operating budget. The

gain or loss depends on the currency of denomination of expected cash flows. These are both

existing transaction exposures and anticipated exposures. The currency of denomination cannot

be changed for existing obligations, or even for implied obligations such as purchase or sales

commitments. In the short run it is difficult to change sales prices or renegotiate factor costs.

Therefore, realized cash flows will differ from those expected in the budget.

The second level impact is on expected medium-run cash flows assuming disequilibrium

conditions. In this case, the firm may not be able to adjust prices and costs to reflect the new

competitive realities caused by a change in exchange rates. The primary problem may be the

reactions of existing competitors. The firm's realized cash flows will differ from its expected

cash flows. The firm's market value may change because of the unanticipated results.

The third level impact is on expected long-run cash flows, meaning those beyond five years. At

this strategic level a firm's cash flows will be influenced by the reactions of both existing

competitors and potential competitors-possible new entrants-to exchange rate changes under

disequilibrium conditions. In fact, all firms that are subject to international competition, whether

they are purely domestic or multinational, are exposed to foreign exchange operating exposure in

the long run whenever foreign exchange markets are not continuously in equilibrium.

Diff: 1

L.O.: 12.1 A Multinational's Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

12.2 Measuring Operating Exposure: Ganado Germany

1) Recently the British Pound suffered an unexpected depreciation in value. Which of the

following actions being considered by Coventry Furniture of London, a purely domestic

furniture manufacturer and retailer, would be considered a highly unlikely response to the

depreciation of the pound?

A) Coventry might choose to maintain its domestic sales prices constant in pound terms.

B) Coventry might try to raise domestic prices because competing imports are now priced higher

in England.

C) Coventry might try to lower domestic prices because competing imports are now priced

higher in England.

D) none of the above

Answer: C

Diff: 2

L.O.: 12.2 Measuring Operating Exposure: Ganado Germany

Skill: Recognition

AACSB: Application of knowledge

2) Recently the Canadian dollar realized an unexpected appreciation in value. Which of the

following actions being considered by Tall Timber Exports, a Canadian logging firm specializing

in exporting raw forest products, would be considered a highly unlikely response to the

appreciation of the Canadian dollar?

A) Tall Timber Exports might lower export prices in an effort to maintain market share.

B) Tall Timber Exports might raise export prices only slightly in an effort to increase market

share.

C) Tall Timber Exports might leave export prices as they are and wait to determine what actions

to take if any in the future.

D) all of the above

Answer: B

Diff: 2

L.O.: 12.2 Measuring Operating Exposure: Ganado Germany

Skill: Recognition

AACSB: Application of knowledge

3) For a firm that competes internationally to sell its products, a depreciation of its domestic

currency relative to markets where the firm exports goods, should eventually result in ________

sales at home and ________ sales abroad, other things equal.

A) fewer; greater

B) fewer; fewer

C) greater; greater

D) greater; fewer

Answer: C

Diff: 2

L.O.: 12.2 Measuring Operating Exposure: Ganado Germany

Skill: Conceptual

AACSB: Application of knowledge

4) Brimmo Motorcycles Inc., a U.S.-based firm, manufactures and sells electric motorcycles both

domestically and internationally. A sudden and unexpected appreciation of the U.S. dollar should

allow sales to ________ at home and ________ abroad. (Assume other factors remain

unchanged.)

A) increase; increase

B) decrease; decrease

C) increase; decrease

D) decrease; increase

Answer: B

Diff: 2

L.O.: 12.2 Measuring Operating Exposure: Ganado Germany

Skill: Conceptual

AACSB: Application of knowledge

5) The strategy management undertakes in response to unexpected changes in exchange rates

depends to a large measure on their opinion about the price elasticity of demand.

Answer: TRUE

Diff: 1

L.O.: 12.2 Measuring Operating Exposure: Ganado Germany

Skill: Recognition

AACSB: Application of knowledge

6) Unexpected changes in exchange rates is never good news for a firm's operating income.

Answer: FALSE

Diff: 1

L.O.: 12.2 Measuring Operating Exposure: Ganado Germany

Skill: Conceptual

AACSB: Application of knowledge

12.3 Strategic Management of Operating Exposure

1) Which of the following is NOT an example of diversifying operations?

A) diversifying sales

B) diversifying location of operations

C) raising funds in more than one country

D) sourcing raw materials in more than one country

Answer: C

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT an example of diversification in financing?

A) raising funds in more than one market

B) raising funds in more than one country

C) diversifying sales

D) All of the above qualify.

Answer: C

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

3) When disequilibria in international markets occur, management can take advantage by:

A) doing nothing if they are already diversified and able to realize beneficial portfolio effects.

B) recognizing disequilibria faster than purely domestic competitors.

C) shifting operational of financing activities to take advantage of the disequilibria.

D) all of the above

Answer: D

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

4) Purely domestic firms will be at a disadvantage to MNEs in the event of market disequilibria

because:

A) domestic firms lack comparative data from its own sources.

B) international firms are already so large.

C) all of the domestic firm's raw materials are imported.

D) None of the above; domestic firms are not at a disadvantage.

Answer: A

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

5) Which of the following is probably NOT an advantage of foreign exchange risk management?

A) the reduction of the variability of cash flows due to domestic business cycles

B) increased availability of capital

C) reduced cost of capital

D) All of the above are potential advantages of foreign exchange risk management.

Answer: D

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

6) Which of the following is NOT an example of a form of political risk that might be avoided or

reduced by foreign exchange risk management?

A) expropriation of assets

B) destruction of raw materials through natural disaster

C) war

D) unfavorable legal changes

Answer: B

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

7) Moral hazard may occur when a firm or individual takes on more risk when it knows that

someone else will "pick up the tab."

Answer: TRUE

Diff: 1

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

8) Management must be able to predict disequilibria in international markets to take advantage of

diversification strategies.

Answer: FALSE

Diff: 1

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

9) If a firm diversifies its financing sources, it will be pre-positioned to take advantage of

temporary deviations from the International Fisher Effect.

Answer: TRUE

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

10) Diversifying the financing base means diversifying sales, location of production facilities,

and raw material sources.

Answer: FALSE

Diff: 1

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

11) The variability of a firm's operating cash flows is probably reduced by international

diversification of its production, sourcing, and sales because exchange rate changes under

disequilibrium conditions are likely to increase the firm's competitiveness in some markets while

reducing it in others.

Answer: TRUE

Diff: 2

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

12) Diversification is possibly the best technique for reducing the problems associated with

international transactions. Provide one example each of international financial diversification and

international operational diversification and explain how the action reduces risk.

Answer: An MNE well known in the financial markets could borrow money in a country in

which the firm receives foreign currency. The MNE could then use the receivables to repay the

loan in the foreign currency and avoid uncertainties in exchange rates.

An MNE could establish production facilities in several countries. This could be beneficial in at

least two ways. First, such diversification reduces the probability of unfavorable changes in

exchange rates for one country from significantly reducing the firm's profitability. Second, an

MNE with facilities in several countries is well positioned by using internal sources to recognize

when a disequilibrium in the market arises.

Diff: 3

L.O.: 12.3 Strategic Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

12.4 Proactive Management of Operating Exposure

1) Which of the following is NOT identified by your authors as a proactive management

technique to reduce exposure to foreign exchange risk?

A) matching currency cash flows

B) cross-currency swaps

C) remaining a purely domestic firm

D) parallel loans

Answer: C

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

2) Which one of the following management techniques is likely to best offset the risk of long-run

exposure to receivables denominated in a particular foreign currency?

A) Borrow money in the foreign currency in question.

B) Lend money in the foreign currency in question.

C) Increase sales to that country.

D) Increase sales in this country.

Answer: A

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

3) Which one of the following management techniques is likely to best offset the risk of long-run

exposure to payables denominated in a particular foreign currency?

A) Borrow money in the foreign currency in question.

B) Lend money in the foreign currency in question.

C) Rely on the Federal Reserve Board to enact monetary policy favorable to your exposure risk.

D) none of the above

Answer: B

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

4) The particular strategy of trying to offset stable inflows of cash from one country with

outflows of cash in the same currency is known as:

A) hedging.

B) diversification.

C) matching.

D) balancing.

Answer: C

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

5) Which of the following is NOT an acceptable hedging technique to reduce risk caused by a

relatively predictable long-term foreign currency inflow of Japanese yen?

A) Import raw materials from Japan denominated in yen to substitute for domestic suppliers.

B) Pay suppliers from other countries in yen.

C) Import raw materials from Japan denominated in dollars.

D) Acquire debt denominated in yen.

Answer: C

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

6) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the

firm chooses to hedge by seeking out potential suppliers in Japan. This hedging strategy is

referred to as:

A) a natural hedge.

B) currency-switching.

C) matching.

D) diversification.

Answer: A

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

7) An MNE has a contract for a relatively predictable long-term inflow of Japanese yen that the

firm chooses to hedge by paying for imports from Canada in Japanese yen. This hedging strategy

is known as:

A) a natural hedge.

B) currency-switching.

C) matching.

D) diversification.

Answer: B

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

8) A U.S. timber products firm has a long-term contract to import unprocessed logs from

Canada. To avoid occasional and unpredictable changes in the exchange rate between the U.S.

dollar and the Canadian dollar, the firms agree to split between the two firms the impact of any

exchange rate movement. This type of agreement is referred to as:

A) risk-sharing.

B) currency-switching.

C) matching.

D) a natural hedge.

Answer: A

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

9) A ________ occurs when two business firms in separate countries arrange to borrow each

other's currency for a specified period of time.

A) natural hedge loan

B) forward loan

C) currency switch loan

D) back-to-back loan

Answer: D

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

10) A Canadian firm with a U.S. subsidiary and a U.S. firm with a Canadian subsidiary agree to

a parallel loan agreement. In such an agreement, the Canadian firm is making a/an ________

loan to the ________ subsidiary while effectively financing the ________ subsidiary.

A) indirect; U.S.; Canadian

B) indirect; Canadian; U.S.

C) direct; U.S.; Canadian

D) direct; Canadian; U.S.

Answer: C

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

11) Which of the following is NOT an important impediment to widespread use of parallel

loans?

A) difficulty in finding an appropriate counterparty

B) the risk that one of the parties will fail to return the borrowed funds when agreed

C) the process does not avoid exchange rate risk

D) All of the above are significant impediments.

Answer: C

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

12) A ________ resembles a back-to-back loan except that it does not appear on a firm's balance

sheet.

A) forward loan

B) currency hedge

C) counterparty

D) currency swap

Answer: D

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

13) A ________ is the term used to describe a foreign currency agreement between two parties to

exchange a given amount of one currency for another, and after a period of time, to give back the

original amounts.

A) matched flow

B) currency swap

C) back-to-back loan

D) none of the above

Answer: B

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

14) A British firm and a U.S. Corporation each wish to enter into a currency swap hedging

agreement. The British firm is receiving U.S. dollars from sales in the U.S. but wants pounds.

The U.S. firm is receiving pounds from sales in Britain but wants dollars. Which of the following

choices would best satisfy the desires of the firms?

A) The British firm pays dollars to a swap dealer and receives pounds from the dealer. The U.S.

firm pays pounds to the swap dealer and receives dollars.

B) The U.S. firm pays dollars to a swap dealer and receives pounds from the dealer. The British

firm pays pounds to the swap dealer and receives dollars.

C) The British firm pays pounds to a swap dealer and receives pounds from the dealer. The U.S.

firm pays dollars to the swap dealer and receives dollars.

D) The British firm pays dollars to a swap dealer and receives dollars from the dealer. The U.S.

firm pays pounds to the swap dealer and receives pounds.

Answer: A

Diff: 3

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

15) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from the

Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar

against the Canadian dollar NRI is finding a continued relationship with ATC to be an

increasingly difficult proposition. In response to NRI's request, ATC has proposed the following

risk-sharing arrangement. First, set the current spot rate as the base rate. As long as spot rates

stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5% range,

ATC will share equally with NRI the difference between the spot rate and the base rate. If the

current spot rate is C$1.20/$, what are the upper and lower limits for trading to take place at

C$1.20?

A) C$1.205/$ - C$1.195/$

B) C$1.15/$ - C$1.25/$

C) C$1.14/$ - C$1.26/$

D) none of the above

Answer: C

Diff: 3

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Analytical

AACSB: Analytical thinking

16) NorthRim Inc. (NRI), imports extreme condition outdoor wear and equipment from The

Allofit Territories Company (ATC) located in Canada. With the steady decline of the U.S dollar

against the Canadian dollar NRI is finding a continued relationship with ATC to be an

increasingly difficult proposition. In response to NRI's request, ATC has proposed the following

risk-sharing arrangement. First, set the current spot rate of C$1.20/$as the base rate. As long as

spot rates stay within 5% (up or down) NRI will pay at the base rate. Any rate outside of the 5%

range, ATC will share equally with NRI the difference between the spot rate and the base rate. If

NRI had a payable of C$100,000 due today and the current spot rate were C$1.17/$, how much

would NRI owe in U.S. dollars?

A) $83,333

B) $85,470

C) $85,837

D) $117,000

Answer: A

Diff: 3

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Analytical

AACSB: Analytical thinking

17) Costs associated with the purchase of sizeable put options positions include each of the

following EXCEPT:

A) the purchase price of the options.

B) the opportunity cost of buying the options rather than diversifying operations to reduce risk.

C) executive salaries of having corporate offices in more than one country.

D) none of the above

Answer: C

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

18) Currency swaps are exclusively for periods of time under one year.

Answer: FALSE

Diff: 1

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

19) Most swap dealers arrange swaps so that each firm that is a party to the transaction does not

know who the counterparty is.

Answer: TRUE

Diff: 1

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

20) Most swap dealers arrange swaps so that each firm that is a party to the transaction knows

who the counterparty is.

Answer: FALSE

Diff: 1

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

21) Swap agreements are treated as off-balance sheet transactions via U.S. accounting methods.

Answer: TRUE

Diff: 1

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

22) Swap agreements are treated as line items on the balance sheet via U.S. accounting methods.

Answer: FALSE

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

23) After being introduced in the 1980s, currency swaps have remained a relatively insignificant

financial derivative instrument.

Answer: FALSE

Diff: 1

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

24) After being introduced in the 1980s, currency swaps have gained increasing importance as

financial derivative instruments.

Answer: TRUE

Diff: 1

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

25) The empirical evidence strongly supports the proposition that contractual hedges can

effectively eliminate operating exposure.

Answer: FALSE

Diff: 2

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Recognition

AACSB: Application of knowledge

26) A British firm has a subsidiary in the U.S., and a U.S. firm, known to the British firm, has a

subsidiary in Britain. Define and then provide an example for each of the following management

techniques for reducing the firm's operating cash flows. The following are techniques to

consider:

a) matching currency cash flows

b) risk-sharing agreements

c) back-to-back or parallel loans

Answer:

a) Matching currency cash flows requires that the British firm with dollar receivables must

establish an equivalent dollar payable. They could do this by borrowing dollars and repaying the

loan with the proceeds from the receivables account. Or they could move all or part of their

operations to the U.S. so that both receivables and payables would be in U.S. dollars.

b) Risk-sharing agreements are contractual clauses whereby both parties agree to an acceptable

range of exchange rates at the time the international sale is made. A spot rate at time of exchange

outside of the agreed upon range results in an adjustment made to the actual exchange rate that

shares the difference between the spot rate and the acceptable range of exchange rates.

c) Back-to-back loans provide for parent-subsidiary cross border financing without incurring

direct currency exposure. For example, using our British and U.S. firms, the British firm could

lend pounds to the U.S. subsidiary in Britain at the same time that the U.S. firm lends an

equivalent amount of dollars to the British subsidiary in the U.S. Later, the loans would be

simultaneously repaid.

Diff: 3

L.O.: 12.4 Proactive Management of Operating Exposure

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 13 Global Cost and Availability of Capital

13.1 Financial Globalization and Strategy

1) If a firm lies within a country with ________ or ________ domestic capital markets, it can

achieve lower global cost and greater availability of capital with a properly designed and

implemented strategy to participate in international capital markets.

A) liquid; segmented

B) liquid; large

C) illiquid; segmented

D) large; illiquid

Answer: C

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

2) Other things equal, a firm that must obtain its long-term debt and equity in a highly illiquid

domestic securities market will probably have a:

A) relatively low cost of capital.

B) relatively high cost of capital.

C) relatively average cost of capital.

D) cost of capital that we cannot estimate from this question.

Answer: B

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

3) Relatively high costs of capital are more likely to occur in:

A) highly illiquid domestic securities markets.

B) highly liquid domestic securities markets.

C) unsegmented domestic securities markets.

D) none of the above

Answer: A

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

4) Reasons that firms may find themselves with relatively high costs of capital include:

A) The firms reside in emerging countries with undeveloped capital markets.

B) The firms are too small to easily gain access to their own national securities market.

C) The firms are family owned and they choose not to access public markets and lose control of

the firm.

D) all of the above

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

5) Which of the following is NOT a contributing factor to the segmentation of capital markets?

A) excessive regulatory control

B) perceived political risk

C) anticipated foreign exchange risk

D) All of the above are contributing factors.

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

6) Which of the following is NOT a contributing factor to the segmentation of capital markets?

A) lack of transparency

B) asymmetric availability of information

C) insider trading

D) All of the above are contributing factors.

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

7) The weighted average cost of capital (WACC) is:

A) the required rate of return for all of a firm's capital investment projects.

B) the required rate of return for a firm's average risk projects.

C) not applicable for use by MNE.

D) equal to 13%.

Answer: B

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

8) The capital asset pricing model (CAPM) is an approach:

A) to determine the price of equity capital.

B) used by marketers to determine the price of saleable product.

C) that can be applied only to domestic markets.

D) none of the above

Answer: A

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

9) Which of the following is NOT a key variable in the equation for the capital asset pricing

model?

A) the risk-free rate of interest

B) the expected rate of return on the market portfolio

C) the marginal tax rate

D) All are important components of the CAPM.

Answer: C

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

10) ________ risk is a function of the variability of expected returns of the firm's stock relative

to the market index and the measure of correlation between the expected returns of the firm and

the market.

A) Systematic

B) Unsystematic

C) Total

D) Diversifiable

Answer: A

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

11) Systematic risk:

A) is the standard deviation of a security's return.

B) is measured with beta.

C) is measured with standard deviation.

D) none of the above

Answer: B

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

12) Which of the following is generally unnecessary in measuring the cost of debt?

A) a forecast of future interest rates

B) the proportions of the various classes of debt a firm proposes to use

C) the corporate income tax rate

D) All of the above are necessary for measuring the cost of debt.

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

13) The after-tax cost of debt is found by:

A) dividing the before-tax cost of debt by (1 - the corporate tax rate).

B) subtracting (1 - the corporate tax rate) from the before-tax cost of debt.

C) multiplying the before-tax cost of debt by (1 - the corporate tax rate).

D) subtracting the corporate tax rate from the before-tax cost of debt.

Answer: C

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

14) A firm whose equity has a beta of 1.0:

A) has greater systematic risk than the market portfolio.

B) stands little chance of surviving in the international financial market place.

C) has less systematic risk than the market portfolio.

D) None of the above is true.

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

15) The difference between the expected (or required) return for the market portfolio and the

risk-free rate of return is referred to as:

A) beta.

B) the geometric mean.

C) the market risk premium.

D) the arithmetic mean.

Answer: C

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

16) If a company fails to accurately predict it's cost of equity, then:

A) the firm's WACC will also be inaccurate.

B) the firm may not be using the proper interest rate to estimate NPV.

C) the firm may incorrectly accept or reject projects based on decisions made using the cost of

capital computed with an incorrect cost of equity.

D) All of the above are true.

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

17) Which of the following statements is NOT true regarding beta?

A) Beta will have a value of less than 1.0 if the firm's returns are less volatile than the market.

B) Beta will have a value of greater than 1.0 if the firm's returns are more volatile than the

market.

C) Beta will have a value of equal to 1.0 if the firm's returns are of equal volatility to the market.

D) All of the statements above are true.

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

18) Which of the following will NOT affect a firm's beta?

A) the choice of the market portfolio against which to compare the variability of a firm's returns

B) the choice of the risk-free security

C) the choice of the time period used to calculate the firm's beta

D) None of the above, because each of them affects the calculation of a firm's beta.

Answer: B

Diff: 1

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

19) Beta may be defined as:

A) the measure of systematic risk.

B) a risk measure of a portfolio.

C) the ratio of the variance of the portfolio to the variance of the market.

D) all of the above

Answer: D

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

20) ________ risk is measured with beta.

A) Systematic

B) Unsystematic

C) International

D) Domestic

Answer: A

Diff: 1

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

21) A fully diversified domestic portfolio has a beta of:

A) 0.0.

B) 1.0.

C) -1.0.

D) There is not enough information to answer this question.

Answer: B

Diff: 1

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

22) Unsystematic risk:

A) is the remaining risk in a well-diversified portfolio.

B) is measured with beta.

C) can be diversified away.

D) all of the above

Answer: C

Diff: 1

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

23) A national securities market is segmented if the required rate of return on securities in that

market differs from comparable securities traded in other, unsegmented markets.

Answer: TRUE

Diff: 1

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

24) Other things equal, an increase in the firm's tax rate will increase the WACC for a firm that

has both debt and equity financing.

Answer: FALSE

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

25) If a firm's expected returns are more volatile than the expected return for the market

portfolio, it will have a beta less than 1.0.

Answer: FALSE

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

26) The WACC is usually used as the risk-adjusted required rate of return for new projects that

are of the same average risk as the firm's existing projects.

Answer: TRUE

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

27) Firms acquire debt in either the form of loans from commercial banks, or by selling new

common stock.

Answer: FALSE

Diff: 1

L.O.: 13.1 Financial Globalization and Strategy

Skill: Recognition

AACSB: Application of knowledge

28) When estimating an average corporate after-tax cost of capital, the component cost of equity

is multiplied by (1-t) to allow for the tax-deductibility of dividend payments.

Answer: FALSE

Diff: 2

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

29) What are the components of the weighted average cost of capital (WACC) and how do they

differ for an MNE compared to a purely domestic firm?

Answer: The WACC considers the proportion or weight of assets financed with debt and the

proportion financed with equity. It also looks at the costs of debt and equity financing and the

firm's corporate tax rate. The difficulty of such a computation is compounded for an MNE

because there are several additional sources of debt financing with different required rates of

return and tax rates for an MNE than for a domestic firm. Also, equity may be sourced in several

different markets and subject to several different regulations of several different countries.

Adding regulatory oversight, multiple sourcing locations, and differing investor expectations

may significantly complicate the process of determining an MNE's cost of capital.

Diff: 3

L.O.: 13.1 Financial Globalization and Strategy

Skill: Conceptual

AACSB: Application of knowledge

13.2 International Portfolio Theory and Diversification

1) In general, the geometric mean will be ________ the arithmetic mean for a series of returns.

A) less than

B) greater than

C) equal to

D) greater than or equal to

Answer: A

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Recognition

AACSB: Application of knowledge

2) The beginning share price for a security over a three-year period was $50. Subsequent year-

end prices were $62, $58 and $64. The arithmetic average annual rate of return and the geometric

average annual rate of return for this stock were:

A) 9.30% and 8.58% respectively.

B) 9.30% and 7.89% respectively.

C) 9.30% and 7.03% respectively.

D) 9.30% and 6.37% respectively.

Answer: A

Diff: 3

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Analytical

AACSB: Application of knowledge

3) A well-diversified portfolio has about ________ of the risk of the typical individual stock.

A) 8%

B) 19%

C) 27%

D) 52%

Answer: C

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Recognition

AACSB: Application of knowledge

4) An internationally diversified portfolio:

A) should result in a portfolio with a lower beta than a purely domestic portfolio.

B) has the same overall risk shape as a purely domestic portfolio.

C) is only about 12% as risky as the typical individual stock.

D) all of the above

Answer: D

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

5) In some respects, internationally diversified portfolios are the same in principle as a domestic

portfolio because:

A) the investor is attempting to combine assets that are perfectly correlated.

B) investors are trying to reduce systematic risk.

C) investors are trying to reduce the total risk of the portfolio.

D) all of the above

Answer: C

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

6) In some respects, internationally diversified portfolios are different from a domestic portfolio

because:

A) investors may also acquire foreign exchange risk.

B) international portfolio diversification increases expected return but does not decrease risk.

C) investors must leave the country to acquire foreign securities.

D) all of the above

Answer: A

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

Instruction 13.1:

Use the information to answer the following question(s).

In September 2009 a U.S. investor chooses to invest $500,000 in German equity securities at a

then current spot rate of $1.30/euro. At the end of one year the spot rate is $1.35/euro.

7) Refer to Instruction 13.1. How many euros will the U.S. investor acquire with his initial

$500,000 investment?

A) €650,000

B) €370,370

C) €500,000

D) €384,615

Answer: D

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Analytical

AACSB: Application of knowledge

8) Refer to Instruction 13.1. At an average price of €60/share, how many shares of stock will the

investor be able to purchase?

A) 8333 shares

B) 6410 shares

C) 6173 shares

D) 10,833 shares

Answer: B

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Analytical

AACSB: Application of knowledge

9) Refer to Instruction 13.1. At the end of the year the investor sells his stock that now has an

average price per share of €57. What is the investor's average rate of return before converting the

stock back into dollars?

A) 5.0%

B) -3.0%

C) -5.0%

D) 3.0%

Answer: C

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Analytical

AACSB: Application of knowledge

10) Refer to Instruction 13.1. At the end of the year the investor sells his stock that now has an

average price per share of €57. What is the investor's average rate of return after converting the

stock back into dollars?

A) -1.35%

B) 5.0%

C) -5.0%

D) -7.24%

Answer: A

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Analytical

AACSB: Application of knowledge

11) A U.S. investor makes an investment in Britain and earns 14% on the investment while the

British pound appreciates against the U.S. dollar by 8%. What is the investor's total return?

A) 22.00%

B) 23.12%

C) 6.00%

D) 4.88%

Answer: B

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Analytical

AACSB: Application of knowledge

12) Which of the following statements is NOT true?

A) International diversification benefits induce investors to demand foreign securities.

B) An international security adds value to a portfolio if it reduces risk without reducing return.

C) Investors will demand a security that adds value.

D) All of the above are true.

Answer: D

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

13) International CAPM (ICAPM) assumes that there is a global market in which the firm's

equity trades, and estimates of the firm's beta, and the market risk premium, must then reflect

this global portfolio.

Answer: TRUE

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

14) Use of the International CAPM (ICAPM) assures that the WACC will be lower than if a

purely domestic market portfolio had been used in the estimation of the cost of equity.

Answer: FALSE

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

15) A global portfolio is an index of all the securities in the world, whereas a world portfolio

represents those securities actually available to an investor.

Answer: FALSE

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Recognition

AACSB: Application of knowledge

16) The CAPM has now become very widely accepted in global business as the preferred

method of calculating the cost of equity for a firm. As a result of this, there is now little debate

over what numerical values should be used in its application.

Answer: FALSE

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

17) The geometric mean will, in all but a few extreme circumstances, yield a larger return than

the arithmetic mean return.

Answer: FALSE

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Recognition

AACSB: Application of knowledge

18) Portfolio diversification can eliminate 100% of risk.

Answer: FALSE

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

19) Increasing the number of securities in a portfolio reduces the unsystematic risk but not the

systematic risk.

Answer: TRUE

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

20) International diversification benefits may induce investors to demand foreign securities.

Answer: TRUE

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

21) If the addition of a foreign security to the portfolio of the investor aids in the reduction of

risk for a given level of return, then the security adds value to the portfolio.

Answer: TRUE

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

22) If the addition of a foreign security to the portfolio of the investor decreases the expected

return for a given level of risk, then the security adds value to the portfolio.

Answer: FALSE

Diff: 1

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

23) One of the elegant beauties of international equity markets is that over the last 100 or so

years, the average market risk premium is almost identical across major industrial countries.

Answer: FALSE

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Recognition

AACSB: Application of knowledge

24) There are potential benefits and risks from raising capital on global markets. Discuss the pros

and cons in terms of risk of raising capital on global markets.

Answer: A portfolio of international stocks represents a portfolio in which foreign securities

have been added. It has the same overall risk shape as the U.S. stock portfolio, but it has a lower

portfolio beta. This means that the international portfolio's market risk is lower than that of a

domestic portfolio. This situation arises because the returns on the foreign stocks are not

perfectly correlated with U.S. stocks (the benefits of international diversification).

The foreign exchange risks of a portfolio, whether it is a securities portfolio or the general

portfolio of activities of the MNE, are reduced through international diversification. But

international portfolio construction is also different in that when the investor acquires assets or

securities from outside the investor's host-country market, the investor may also be acquiring a

foreign currency-denominated asset. Thus, the investor has actually acquired two additional

assets—the currency of denomination and the asset subsequently purchased with the currency—

one asset in principle, but two in expected returns and risks. You should see, however, that the

presence of currency risk may alter the correlations associated with securities in different

countries and currencies.

Diff: 2

L.O.: 13.2 International Portfolio Theory and Diversification

Skill: Conceptual

AACSB: Application of knowledge

13.3 The Role of International Portfolio Investors

1) The primary goal of both domestic and international portfolio managers is:

A) to maximize return for a given level of risk, or to minimize risk for a given level of return.

B) to minimize the number of unique securities held in their portfolio.

C) to maximize their WACC.

D) all of the above

Answer: A

Diff: 1

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Conceptual

AACSB: Application of knowledge

2) Which of the following is NOT a portfolio diversification technique used by portfolio

managers?

A) diversify by type of security

B) diversify by the size of capitalization of the securities held

C) diversify by country

D) All of the above are diversification techniques.

Answer: D

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

3) If all capital markets are fully integrated, securities of comparable expected return and risk

should have the same required rate of return in each national market after adjusting for:

A) time of day and language requirements.

B) political risk and time lags.

C) foreign exchange risk and political risk.

D) foreign exchange risk and the spot rate.

Answer: C

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

4) Capital market segmentation is a financial market imperfection caused mainly by:

A) government constraints.

B) institutional practices.

C) investor perceptions.

D) all of the above

Answer: D

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

5) Capital market imperfections leading to financial market segmentation include:

A) asymmetric information between domestic and foreign-based investors.

B) high securities transaction costs.

C) foreign exchange risks.

D) all of the above

Answer: D

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

6) Capital market imperfections leading to financial market segmentation include:

A) political risks.

B) corporate governance differences.

C) regulatory barriers.

D) all of the above

Answer: D

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

7) The authors refer to companies that have access to a ________ as MNEs, and firms without

such access are identified as ________.

A) global cost and availability of capital; domestic firms

B) large domestic capital market; geographically challenged

C) world financial markets; antiquated

D) none of the above

Answer: A

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

8) The MNE can ________ its ________ by gaining access to markets that are more liquid

and/or less segmented than its own.

A) increase; MCC

B) decrease; MCC

C) maintain; MRR

D) none of the above

Answer: B

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

9) Portfolio theory assumes that investors are risk-averse. This means that investors:

A) cannot be induced to make risky investments.

B) prefer more risk to less for a given return.

C) will accept some risk, but not unnecessary risk.

D) All of the above are true.

Answer: C

Diff: 1

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Conceptual

AACSB: Application of knowledge

10) The optimal capital budget:

A) occurs where the marginal cost of capital equals the marginal rate of return of the opportunity

set of projects.

B) is typically larger for purely domestic firms than for MNEs.

C) is an illusion found only in international finance textbooks.

D) none of the above

Answer: A

Diff: 1

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

11) Internationally diversified portfolios often have a lower rate of return and almost always

have a higher level of portfolio risk than their domestic counterparts.

Answer: FALSE

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Conceptual

AACSB: Application of knowledge

12) Empirical tests of market efficiency fail to show that most major national markets are

reasonably efficient.

Answer: FALSE

Diff: 1

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

13) A MNE's marginal cost of capital is constant for considerable ranges in its capital budget, but

this statement cannot be made for most domestic firms.

Answer: TRUE

Diff: 1

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Conceptual

AACSB: Application of knowledge

14) Capital market segmentation is a financial market imperfection caused mainly by

government constraints, institutional practices, and investor perceptions.

Answer: TRUE

Diff: 1

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

15) Since the 1980s and 1990s, segmentation in global financial markets has been reduced. As a

result of this, the correlation among securities markets has increased, thereby reducing, but not

eliminating, the benefits of international portfolio diversification.

Answer: TRUE

Diff: 1

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Recognition

AACSB: Application of knowledge

16) Capital market segmentation is a financial market imperfection caused mainly by

government constraints, institutional practices, and investor perceptions. List and explain three

imperfections.

Answer: The following are the most important imperfections: 1) Asymmetric information

between domestic and foreign-based investors, 2) Lack of transparency, 3) High securities

transaction costs, 4) Foreign exchange risks, 5) Political risks, 6) Corporate governance

differences, 7) Regulatory barriers.

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Conceptual

AACSB: Application of knowledge

17) Market imperfections do not necessarily imply that national securities markets are

inefficient. Develop an argument as to why this is possible.

Answer: A national securities market can be efficient in a domestic context and yet segmented

in an international context. According to finance theory, a market is efficient if security prices in

that market reflect all available relevant information and adjust quickly to any new relevant

information. According to finance theory, a market is efficient if security prices in that market

reflect all available relevant information and adjust quickly to any new relevant information.

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Conceptual

AACSB: Application of knowledge

18) Most observers believe that for better or for worse, we have achieved a global market for

securities. Discuss the major changes in the international markets of securities: during the 1980s,

during the 1990s and the current conditions.

Answer: During the 1980s, numerous firms cross-listed on major foreign exchanges and were

successful in lowering their WACC and increasing its availability. During the 1990s, national

restrictions on cross-border portfolio investment were gradually eased under pressure from the

Organization for Economic Cooperation and Development. Liberalization of European securities

markets was accelerated because of the European Union's efforts to develop a single European

market without barriers. Emerging nation markets followed suit, as did the former Eastern Bloc

countries after the breakup of the Soviet Union. Emerging national markets have often been

motivated by the need to source foreign capital to finance large-scale privatization.

Now, market segmentation has been significantly reduced, although the liquidity of individual

national markets remains limited. The good news is that many firms have been assisted to

become MNEs because they now have access to a global cost and availability of capital. The bad

news is that the correlation among securities markets has increased, thereby reducing, but not

eliminating, the benefits of international portfolio diversification. Globalization of securities

markets has also led to more volatility and speculative behavior, as shown by the emerging

market crises of the 1995-2001 period, and the 2008-2009 global credit crisis.

Diff: 2

L.O.: 13.3 The Demand for Foreign Securities: The Role of International Portfolio Investors

Skill: Conceptual

AACSB: Application of knowledge

13.4 The Cost of Capital for MNEs Compared to Domestic Firms

1) Theoretically, most MNEs should be in a position to support higher ________ than their

domestic counterparts because their cash flows are diversified internationally.

A) equity ratios

B) debt ratios

C) temperatures

D) none of the above

Answer: B

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Conceptual

AACSB: Application of knowledge

2) According to your authors, diversifying cash flows internationally may help MNEs reduce the

variability of cash flows because:

A) of a lack of competition among international firms.

B) of an offset to cash flow variability caused by exchange rate variability.

C) returns are not perfectly correlated between countries.

D) none of the above

Answer: C

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

3) Which of the following statements is NOT true regarding MNEs when compared to purely

domestic firms?

A) MNEs tend to rely more on short and intermediate term debt.

B) MNEs have greater foreign exchange risk.

C) MNEs have greater costs of asymmetric information.

D) MNEs have higher agency costs.

Answer: A

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Conceptual

AACSB: Application of knowledge

4) Empirical research has found that systematic risk for MNEs is greater than that for their

domestic counterparts. This could be due to:

A) the fact that the increase in the correlation of returns between the market and the firm is less

than the increase in the standard deviation of returns of the firm.

B) the fact that the decrease in the correlation of returns between the market and the firm is

greater than the increase in the standard deviation of returns of the firm.

C) the reduction in the correlation of returns between the firm and the market is less than the

increase in the variability of returns caused by factors such as asymmetric information, foreign

exchange risk, and the like.

D) None of the above; systematic risk is less for MNEs than for their domestic counterparts.

Answer: C

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Conceptual

AACSB: Application of knowledge

5) Empirical studies indicate that MNEs have higher costs of capital than purely domestic firms.

This could be due to higher levels of:

A) political risk.

B) exchange rate risk.

C) agency costs.

D) all of the above

Answer: D

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

6) Despite the theoretical elegance of this hypothesis, empirical studies have come to the

opposite conclusion. Despite the favorable effect of international diversification of cash flows,

bankruptcy risk was only about the same for MNEs as for domestic firms. However, MNEs

faced higher costs for each of the following EXCEPT:

A) agency costs.

B) political risk.

C) asymmetric information.

D) In fact, each of these costs were higher for the MNE than for the domestic firm.

Answer: D

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

7) Empirical studies indicate that WACC for an MNE is higher than for their domestic

competitors. Reasons cited for this increased cost include all of the following EXCEPT:

A) agency costs.

B) foreign exchange risk.

C) political risk.

D) All of the above are cited as reasons for an MNE's increased WACC.

Answer: D

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

8) Because of the international diversification of cash flows, the risk of bankruptcy for MNEs is

significantly lower than that for purely domestic firms.

Answer: FALSE

Diff: 1

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

9) The opportunity set of projects is typically smaller for MNEs than for purely domestic firms

because international markets are typically specialized niches.

Answer: FALSE

Diff: 1

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

10) Surprisingly, empirical studies find that MNEs have a higher level of systematic risk than

their domestic counterparts.

Answer: TRUE

Diff: 1

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

11) Empirical studies indicate that MNEs have a lower debt/capital ratio than domestic

counterparts, indicating that MNEs have a lower cost of capital.

Answer: FALSE

Diff: 2

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Recognition

AACSB: Application of knowledge

12) What do theory and empirical evidence say about capital structure and the cost of capital for

MNEs versus their domestic counterparts?

Answer: In theory, MNEs should be able to support greater amounts of debt due to reduced

variability of cash flows brought about by diversification across countries. And, because of this

reduced risk borne by MNEs, they should also have a lower cost of capital. However, empirical

research finds that domestic firms tend to use greater amounts of short and intermediate debt

than do MNEs and that the cost of capital is greater for MNEs due to increased agency costs,

political risk, exchange rate risk, and asymmetric information.

Diff: 3

L.O.: 13.4 The Cost of Capital for MNEs Compared to Domestic Firms

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 14 Funding the Multinational Firm

14.1 Designing a Strategy to Source Capital Globally

1) The choice of when and how to source capital globally is usually aided early on by the advice

of:

A) an investment banker.

B) your stock broker.

C) a commercial banker.

D) an underwriter.

Answer: A

Diff: 1

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Recognition

AACSB: Application of knowledge

2) Investment banking services include which of the following?

A) advising when a security should be cross-listed

B) preparation of stock prospectuses

C) help to determine the price of the issue

D) all of the above

Answer: D

Diff: 1

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Conceptual

AACSB: Application of knowledge

3) Which of the following is the typical order of sourcing capital abroad?

A) an international bond issue, then cross-listing the outstanding issues on other exchanges, then

an international bond issue in the target market

B) an international bond issue in the target market, then cross-listing the outstanding issues on

other exchanges, then an international bond issue

C) an international bond issue in less prestigious markets, then an international bond issue in the

target market, and ultimately a eurobond issue

D) cross-listing the outstanding issues on other exchanges, then an international bond issue, then

an international bond issue in the target market

Answer: C

Diff: 2

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Conceptual

AACSB: Application of knowledge

4) Which of the following is the typical first step sourcing capital abroad?

A) an international bond issue placed on a more prestigious foreign market

B) an international bond issue in the eurobond market

C) an international bond issue placed on a less prestigious foreign market

D) issue equity in one of the less prestigious markets to attract the attention of international

investors first

Answer: C

Diff: 2

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Recognition

AACSB: Application of knowledge

5) By cross listing and selling its shares on a foreign stock exchange, a firm typically tries to

accomplish which of the following?

A) improve the liquidity of its existing shares

B) increase its share price

C) increase the firm's visibility

D) all of the above

Answer: D

Diff: 2

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Conceptual

AACSB: Application of knowledge

6) Most firms raise their initial capital in foreign markets.

Answer: FALSE

Diff: 1

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Conceptual

AACSB: Application of knowledge

7) The ultimate step sourcing capital abroad would be to place a directed equity issue in a

prestigious target market or a euroequity issue in global equity markets.

Answer: TRUE

Diff: 1

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Recognition

AACSB: Application of knowledge

8) Sourcing capital abroad usually follows a logic path. List in sequential order three corporate

strategies in internationalizing the cost of capital.

Answer: Most firms raise their initial capital in their own domestic market. Most firms should

start sourcing abroad with an international bond issue. It could be placed on a less prestigious

foreign market. This could be followed by an international bond issue in a target market or in the

eurobond market. The next step might be to cross-list and issue equity in one of the less

prestigious markets in order to attract the attention of international investors. The next step could

be to cross-list shares on a highly liquid prestigious foreign stock exchange such as London

(LSE), NYSE, Euronext, or NASDAQ. The ultimate step sourcing capital abroad could be to

place a directed equity issue in a prestigious target market or a euroequity issue in global equity

markets.

Diff: 2

L.O.: 14.1 Designing a Strategy to Source Capital Globally

Skill: Conceptual

AACSB: Application of knowledge

14.2 Optimal Financial Structure

1) Which financial economists are most closely associated with the financial theory of optimal

capital structure?

A) Modigliani and Miller

B) Fama, Fisher, Jensen, and Roll

C) Black and Scholes

D) Markowitz and Sharpe

Answer: A

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

2) For most firms, the cost of capital decreases to a low point as the firm ________ debt

financing. At some point beyond this optimal level, the cost of capital increases as the amount of

debt ________.

A) decreases; increases

B) decreases; decreases

C) increases; increases

D) increases; decreases

Answer: C

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

3) One of the most important factors in making debt less expensive than equity is:

A) the tax deductibility of depreciation.

B) the tax deductibility of equity.

C) the tax deductibility of dividends.

D) the tax deductibility of interest.

Answer: D

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

4) One of the most important factors in making debt less expensive than equity is:

A) the seniority of equity obligations to debt claims.

B) the tax deductibility of dividends.

C) the tax deductibility of equity.

D) the seniority of debt obligations to equity claims.

Answer: D

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

5) Which of the following is NOT a factor offsetting the tax advantage of debt as a source of

financing?

A) increased agency costs

B) increased probability of financial distress (bankruptcy) due to fixed interest payments

C) alternative tax shields to those supplied by interest payments

D) All of the above offset the tax advantage of debt as a source of financing.

Answer: D

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

6) Most financial theorists believe that the optimal capital structure is a ________ with a debt to

total value ratio somewhere around ________.

A) point; 50%

B) point; 25%

C) range; 30%-60%

D) range; 10%-40%

Answer: C

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

7) Not all firms have the same optimal capital structure. Factors that might influence a firm's

capital structure include:

A) the industry in which it operates.

B) the volatility of its sales and operating income.

C) the collateral value of its assets.

D) all of the above

Answer: D

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

8) MNEs situated in countries with small illiquid and segmented markets are most like:

A) small domestic U.S. firms in that they must rely on internally generated funds and bank

borrowing.

B) large U.S. MNEs in that they are all MNEs and have worldwide markets and sources of

financing.

C) small domestic U.S. firms in that they have a strong niche market in the U.S.

D) None of the above is true.

Answer: A

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

9) Which of the following were NOT identified by the authors as a variable that needs to be

modified in the domestic theory of optimal financial structures to accommodate the case of the

multinational enterprise?

A) financial distress

B) availability of capital

C) diversification of cash flows

D) foreign exchange risk

Answer: A

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

10) In theory, the MNE should support ________ debt ratios than a purely domestic firm because

their cash flows are ________.

A) lower; more stable due to international diversification

B) lower; less stable due to international diversification

C) higher; more stable due to international diversification

D) higher; less stable due to international diversification

Answer: C

Diff: 2

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

11) TropiKana Inc., a U.S firm, has just borrowed $1,000,000 to make improvements to an

Italian fruit plantation and processing plant. If the interest rate is 6.00% per year, how much

interest will they pay in the first year?

A) $6,000

B) $60,000

C) $600,000

D) €60,000

Answer: B

Diff: 3

L.O.: 14.2 Optimal Financial Structure

Skill: Analytical

AACSB: Analytical thinking

12) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an

Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro

depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of

the first year, how much interest will TropiKana pay at the end of the first year (rounded)?

A) $55,000

B) €74,250

C) $74,250

D) $77,000

Answer: C

Diff: 3

L.O.: 14.2 Optimal Financial Structure

Skill: Analytical

AACSB: Analytical thinking

13) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an

Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro

appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of

the first year, how much interest will TropiKana pay at the end of the first year (rounded)?

A) $55,000

B) $79,750

C) $77,000

D) $37,931

Answer: B

Diff: 3

L.O.: 14.2 Optimal Financial Structure

Skill: Analytical

AACSB: Analytical thinking

14) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an

Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro

appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of

the first year, how much interest and principle will TropiKana pay at the end of the first year if

they repay the entire loan plus interest (rounded)?

A) $1,529,750

B) €1,529,750

C) $1,055,000

D) $1,477,000

Answer: A

Diff: 3

L.O.: 14.2 Optimal Financial Structure

Skill: Analytical

AACSB: Analytical thinking

15) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an

Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro

depreciates against the dollar from $1.40/€ at the time the loan was made to $1.35/€ at the end of

the first year, how much interest and principle will TropiKana pay at the end of the first year if

they repay the entire loan plus interest (rounded)?

A) $1,477,000

B) $1,055,000

C) €1,424,250

D) $1,424,250

Answer: D

Diff: 3

L.O.: 14.2 Optimal Financial Structure

Skill: Analytical

AACSB: Analytical thinking

16) TropiKana Inc., a U.S firm, has just borrowed euro 1,000,000 to make improvements to an

Italian fruit plantation and processing plant. If the interest rate is 5.50% per year and the Euro

appreciates against the dollar from $1.40/€ at the time the loan was made to $1.45/€ at the end of

the first year, what is the before tax cost of capital if the firm repays the entire loan plus interest

(rounded)?

A) 1.73%

B) 5.50%

C) 10.50%

D) 9.27%

Answer: D

Diff: 3

L.O.: 14.2 Optimal Financial Structure

Skill: Analytical

AACSB: Analytical thinking

17) Financial theory has at last provided us with a single optimal capital structure for domestic

firms.

Answer: FALSE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

18) Financial practice suggests that there is a range for an optimal capital structure for a firm

within an industry rather than a specific optimal ratio of debt to equity.

Answer: TRUE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

19) In part because of access to global markets, MNEs are better able than their domestic

counterparts to maintain their desired debt ratio even when raising new capital.

Answer: TRUE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

20) When a firm borrows in a foreign currency, the effective cost is the foreign interest rate plus

an adjustment for changes in the exchange rate.

Answer: TRUE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

21) The domestic theory of optimal capital structure does not need to be modified for MNEs.

Answer: FALSE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

22) Portfolio diversification of domestic firms reduces risk because cash flows are not perfectly

correlated. The same reasoning is often argued for MNEs diversifying into international markets.

Answer: TRUE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

23) In theory multinational firms are in a better position than domestic firms to support higher

debt ratios.

Answer: TRUE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

24) A significant advantage of borrowing foreign currency-denominated bonds is that the

borrower need not worry about relative changes in the value of the home currency.

Answer: FALSE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

25) For firms to raise capital in international markets, it is more important to adhere to capital

structure ratios similar to those found in the United States and United Kingdom than to those in

the firm's home country.

Answer: TRUE

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Recognition

AACSB: Application of knowledge

26) In theory multinational firms are in a better position than domestic firms to support higher

debt ratios. Provide an argument as to why this could be true and discuss the empirical research

findings about U.S.-based MNEs.

Answer: Access to capital in global markets allows an MNE to lower its cost of equity and debt

compared with most domestic firms. The theoretical possibility exists that multinational firms

are in a better position than domestic firms to support higher debt ratios because their cash flows

are diversified internationally. The probability of a firm's covering fixed charges under varying

conditions in product, financial, and foreign exchange markets should increase if the variability

of its cash flows is minimized. The diversification argument has been challenged by empirical

research findings that MNEs in the United States actually have lower debt ratios than their

domestic counterparts. The agency costs of debt were higher for the MNEs, as were political

risks, foreign exchange risks, and asymmetric information.

Diff: 1

L.O.: 14.2 Optimal Financial Structure

Skill: Conceptual

AACSB: Application of knowledge

14.3 Raising Equity Globally

1) A/An ________ is defined as one that is targeted at investors in a single country and

underwritten in whole or part by investment institutions from that country.

A) SEC rule 144a placement

B) directed public share issue

C) Euroequity public issue

D) strategic alliance

Answer: B

Diff: 2

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

2) The term "euro" as used in the euro equity market implies:

A) the issuers are located in Europe.

B) the investors are located in Europe.

C) both A and B

D) none of the above

Answer: D

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

3) Strategic alliances are normally formed by firms that expect to gain synergies from which of

the following?

A) economies of scale

B) economies of scope

C) complementary marketing

D) all of the above

Answer: D

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Conceptual

AACSB: Application of knowledge

4) A multinational firm that proceeds to raise capital outside of its domestic market is ultimately

in search of an issuance — the IPO or SPO. But often issuances must be preceded by listings, in

which the shares are traded on an exchange and, therefore, in a specific country market. The

listing serves the following purposes EXCEPT:

A) gaining name recognition.

B) reducing the compliance costs.

C) gaining visibility.

D) preparing the market for an issuance.

Answer: B

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

5) The public pathway to raise equity capital outside of its home market includes the following

EXCEPT:

A) Euroequity issue.

B) Strategic Partner/Alliance.

C) shares sold to a specific market or exchange.

D) seasoned offering.

Answer: B

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Conceptual

AACSB: Application of knowledge

6) The initial issuance of shares by a company in an IPO typically represents no more than:

A) 25%.

B) 35%.

C) 45%.

D) 55%.

Answer: A

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

7) Which of the following is a characteristic of an euroequity issue?

A) an initial public offering of euro denominated securities

B) the issuers are located in Europe

C) the investors are located in Europe

D) is an offering on multiple exchanges in multiple countries at the same time

Answer: D

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

8) Which of the following high profile euroequity issues was NOT also a privatization?

A) British Telecommunications

B) Gucci

C) YPF Sociedad Anónima

D) Telefonos de Mexico

Answer: B

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

9) Once a firm has "gone public," it is open to a considerably higher level of public scrutiny.

Answer: TRUE

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

10) A distinction about the publicly traded firm's shares is that they raise capital with the daily

rise and fall of their share prices.

Answer: TRUE

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

11) A euroequity issue is an initial public offering of euro denominated securities.

Answer: FALSE

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Recognition

AACSB: Application of knowledge

12) List and discuss three public pathway strategies for a MNE for raising equity capital outside

its home market.

Answer: A euroequity or euroequity issue is an initial public offering on multiple exchanges in

multiple countries at the same time. A directed public share issue or directed issue is defined as

one that is targeted at investors in a single country and underwritten in whole or in part by

investment institutions from that country. Depositary receipts (DRs) are negotiable certificates

issued by a bank to represent the underlying shares of stock that are held in trust at a foreign

custodian bank.

Diff: 1

L.O.: 14.3 Raising Equity Globally

Skill: Conceptual

AACSB: Application of knowledge

14.4 Depositary Receipts

1) ________ are negotiable certificates issued by a bank to represent the underlying shares of

stock, which are held in trust at a foreign custodian bank.

A) Negotiable CDs

B) International mutual funds

C) Depositary receipts

D) Eurodeposits

Answer: C

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

2) Depositary receipts traded outside the United States are called ________ depositary receipts.

A) Euro

B) Global

C) American

D) none of the above

Answer: B

Diff: 1

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

3) Each ADR represents ________ of the shares of the underlying foreign stock.

A) a multiple

B) 100

C) 1

D) ADRs have nothing to do with foreign stocks.

Answer: A

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT an advantage of ADRs to U.S. shareholders?

A) Transfer of ownership is done in the U.S. in accordance with U.S. laws.

B) In the event of the death of the shareholder, the estate does not go through a foreign court.

C) Settlement for trading is generally faster in the United States.

D) All of the above are advantages of ADRs.

Answer: D

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

5) ADRs that are created at the request of a foreign firm wanting its shares traded in the United

States are:

A) facilitated.

B) unfacilitated.

C) sponsored.

D) unsponsored.

Answer: C

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

6) Who pays the costs of creating a sponsored ADR?

A) the foreign firm whose stocks underlie the ADR

B) the U.S. bank creating the ADR

C) both the U.S. bank and the foreign firm

D) the SEC since they require the regulation

Answer: A

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

7) Level I ADRs trade primarily:

A) on the New York Stock Exchange.

B) on the American Stock Exchange.

C) over the counter or pink sheets.

D) Level I ADRs typically do not trade at all, but instead are privately issued and held until

maturity.

Answer: C

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

8) Level II ADRs must meet:

A) U.S. GAAP standards.

B) home country accounting standards.

C) both U.S. GAAP and home country standards.

D) none of the above

Answer: A

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Conceptual

AACSB: Application of knowledge

9) Level ________ is the easiest standard to satisfy for issuing ADRs.

A) 144a

B) III

C) II

D) I

Answer: D

Diff: 1

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

10) Level III ADR commitment applies to:

A) firms that want to list existing shares on the NYSE.

B) banks issuing foreign mutual funds.

C) ADR issues of under $25,000.

D) the sale of a new equity issued in the United States.

Answer: D

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

11) ADRs cannot be exchanged for the underlying shares of the foreign stock, therefore,

arbitrage cannot keep the prices in line with the foreign price of the stock.

Answer: FALSE

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Conceptual

AACSB: Application of knowledge

12) An unsponsored ADR may be initiated without the approval of the foreign firm with the

underlying stock.

Answer: FALSE

Diff: 1

L.O.: 14.4 Depositary Receipts

Skill: Recognition

AACSB: Application of knowledge

13) ADRs are considered an effective way for firms to improve the liquidity of their stock,

especially if the home market is small and illiquid.

Answer: TRUE

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Conceptual

AACSB: Application of knowledge

14) Depositary Receipts intra-market trades account for more than 90% of all DR trading today.

Answer: TRUE

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Conceptual

AACSB: Application of knowledge

15) One of the benefits of investing in Global Registered Shares (GRS) is that GRS allow to

invest in foreign companies without foreign exchange risk.

Answer: FALSE

Diff: 2

L.O.: 14.4 Depositary Receipts

Skill: Conceptual

AACSB: Application of knowledge

16) ADRs are a popular investment tool for many U.S. investors. In recent years several

alternatives for investing in foreign equity securities have become available for U.S. investors,

yet ADRs remain popular. Define what an ADR is and provide at least three examples of the

advantages they may hold over alternative foreign investment vehicles for U.S. investors.

Answer: Depositary receipts are negotiable certificates issued by a bank to represent the

underlying shares of stock held in trust at a foreign custodian bank. Those receipts traded in the

U.S. and denominated in dollars are called American depositary receipts (ADR). Because ADRs

can be exchanged for the underlying foreign security, arbitrage keeps the prices in line. Even

though U.S. investors can invest directly into some foreign equity markets, ADRs do offer some

technical advantages. Among those advantages are that dividends are received in dollars rather

than a foreign currency, ADRs are in registered form rather than bearer form, transfer of

ownership is done in accordance with U.S. laws, and in the event of death, probate is in the U.S.

and not abroad. Taxes are easier, trading costs are typically lower, and settlement is also faster.

Diff: 3

L.O.: 14.4 Depositary Receipts

Skill: Conceptual

AACSB: Application of knowledge

17) List and describe three differences and advantages of Global Registered Shares (GRS) over

American Depositary Receipts (ADRs).

Answer: Depositary receipts are negotiable certificates issued by a bank to represent the

underlying shares of stock held in trust at a foreign custodian bank. Those receipts traded in the

U.S. and denominated in dollars are called American depositary receipts (ADR). ADRs do offer

some technical advantages: dividends are received in dollars rather than a foreign currency,

ADRs are in registered form rather than bearer form, transfer of ownership is done in accordance

with U.S. laws, and in the event of death, probate is in the U.S. and not abroad. Taxes are easier,

trading costs are typically lower, and settlement is also faster.

A global registered share (GRS) is a share of equity that is traded across borders and markets

without conversion, where one share on the home exchange equals one share on the foreign

exchange. If target pricing is important in key markets like that of the U.S., then the ADR offers

better opportunities for a foreign firm to gain greater presence and activity. There are two

fundamental arguments in favor of GRSs over ADRs, both based on pure forces of

globalization:1) Investors and markets alike will continue to grow, 2) Regulations governing

security trading across country markets will continue to converge towards a common set of

global principles, eliminating the need for securities customized for local market attributes or

requirements. Other potential distinctions include the possibility of retaining all voting rights

(GRSs do by definition while some ADRs may not) and the general principle that ADRs are

designed for one singular cultural and legal environment—the United States.

Diff: 3

L.O.: 14.4 Depositary Receipts

Skill: Conceptual

AACSB: Application of knowledge

14.5 Private Placement

1) Which of the following was NOT identified by the authors as an alternative instrument to

source equity in global markets?

A) sale of a directed public share issue to investors in a target market

B) private placements under SEC rule 144a

C) sale of shares to private equity funds

D) All of the above are alternatives to source equity instruments.

Answer: D

Diff: 2

L.O.: 14.5 Private Placement

Skill: Recognition

AACSB: Application of knowledge

2) Private equity funds (PEF) differ from traditional venture capital (VC) funds in that:

A) VC operates mainly in lesser-developed countries while PEF do not.

B) VC typically invests in family business whereas PEF do not.

C) VC is almost unavailable to emerging markets while PEF capital is available.

D) All of the above are true.

Answer: C

Diff: 2

L.O.: 14.5 Private Placement

Skill: Conceptual

AACSB: Application of knowledge

3) By cross-listing shares on a foreign exchange, you can expect:

A) no share price effect for foreign firms that cross-list on major U.S. exchanges.

B) a positive share price effect for foreign firms that cross-list on major U.S. exchanges.

C) a negative share price effect for foreign firms that cross-list on major U.S. exchanges.

D) none of the above

Answer: B

Diff: 2

L.O.: 14.5 Private Placement

Skill: Recognition

AACSB: Application of knowledge

4) In addition to gaining liquidity, which of the following could also be considered a legitimate

reason for cross-listing equity?

A) enhance a firm's local image

B) become more familiar with the local financial community

C) get better local press coverage

D) all of the above

Answer: D

Diff: 2

L.O.: 14.5 Private Placement

Skill: Conceptual

AACSB: Application of knowledge

5) The worldwide trend toward fuller and more standardized disclosure rules should ________

the cost of equity capital.

A) increase

B) decrease

C) have no impact on

D) none of the above

Answer: B

Diff: 2

L.O.: 14.5 Private Placement

Skill: Recognition

AACSB: Application of knowledge

6) SEC rule 144A permits institutional buyers to trade privately placed securities without the

previous holding periods restrictions and without requiring SEC registration.

Answer: TRUE

Diff: 1

L.O.: 14.5 Private Placement

Skill: Recognition

AACSB: Application of knowledge

7) Private equity funds are best known for buying control of private owned firms, taking them

publicly, improving management, and then reselling them after one to three years.

Answer: FALSE

Diff: 1

L.O.: 14.5 Private Placement

Skill: Recognition

AACSB: Application of knowledge

8) Private equity funds appear to have a longer time horizon than traditional venture capital

funds.

Answer: TRUE

Diff: 1

L.O.: 14.5 Private Placement

Skill: Recognition

AACSB: Application of knowledge

9) The least liquid stock markets offer little liquidity for their own domestic firms, and are of

little value to foreign firms.

Answer: TRUE

Diff: 1

L.O.: 14.5 Private Placement

Skill: Conceptual

AACSB: Application of knowledge

10) Private equity funds differ from traditional venture capital funds. List and discuss three

differences between them.

Answer: Private equity funds differ from traditional venture capital funds. VC funds usually

1) operate mainly in highly developed countries, 2) invest in start-up firms with the goal of

exiting the investment with an IPO placed in those same highly liquid markets, 3) very little VC

is available in emerging markets, partly because it would be difficult to exit with an IPO in an

illiquid market. The same exiting problem faces the private equity funds, but they appear to have

a longer time horizon, 4) VC funds appear to have a shorter time horizon, 5) Private equity funds

invest in already mature and profitable companies, 6) Private equity funds are content with

growing companies through better management and mergers with other firms.

Diff: 3

L.O.: 14.5 Private Placement

Skill: Conceptual

AACSB: Application of knowledge

14.6 Raising Debt Globally

1) ________ are domestic currencies of one country on deposit in a second country.

A) LIBORs

B) Eurocurrencies

C) Federal funds

D) Discount window deposits

Answer: B

Diff: 1

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

2) Of the following, which was NOT cited by the authors as a valuable function provided by the

Eurocurrency market?

A) Eurocurrency deposits are an efficient and convenient money market device for holding

excess corporate liquidity.

B) Eurocurrency deposits are a tool used by the Federal Reserve to regulate the money supply of

countries that peg their currency against the U.S. dollar.

C) The Eurocurrency market is a major source of short-term bank loans to finance corporate

working capital needs.

D) All of the above were cited by the authors.

Answer: B

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

3) Eurobanks are:

A) banks where Eurocurrencies are deposited.

B) major world banks that conduct a Eurocurrency business in addition to normal banking

activities.

C) financial intermediaries that simultaneously bid for time deposits in and make loans in a

currency other than that of the currency of where it is located.

D) All of the above are descriptions of a Eurobank.

Answer: D

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

4) Eurocredits are:

A) bank loans to MNEs and others denominated in a currency other than that of the country

where the bank is located.

B) typically variable rate and tied to the LIBOR.

C) usually for maturities of six months or less.

D) All of the above are true.

Answer: D

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Conceptual

AACSB: Application of knowledge

5) In general, which has the shorter maturity and is more appropriate for funding short-term

inventory needs?

A) commercial paper

B) Euro-Medium-Term notes (EMTNs)

C) the international bond market

D) all of the above

Answer: A

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

6) Foreign bonds sold in the United States are nicknamed "Yankee bonds," foreign bonds sold in

Japan are called "Samurai bonds." What are foreign bonds sold in the United Kingdom

nicknamed?

A) "Union Jacks"

B) "Royalty"

C) "Bulldogs"

D) "Churchill's"

Answer: C

Diff: 1

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

7) A ________ is a bond underwritten by a syndicate from a single country, sold within in that

country, denominated in that country's currency, but the issuer is from outside that country.

A) foreign bond

B) Eurobond

C) domestic bond

D) none of the above

Answer: A

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

8) The eurobond market owes its existence to all of the following reasons unique factors

EXCEPT:

A) free bond ratings.

B) the absence of regulatory interference.

C) less stringent disclosure practices.

D) favorable tax treatment.

Answer: A

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

9) Eurocurrencies are NOT the same as the euro developed for the common European currency.

Answer: TRUE

Diff: 1

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

10) The Eurocurrency market continues to thrive because it is a large international money market

relatively free of governmental regulation and interference.

Answer: TRUE

Diff: 1

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

11) Moody's rates international bonds at the request of the issuer with the stipulation that

Moody's will publish the ratings even if the ratings are unfavorable.

Answer: FALSE

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

12) Eurobonds offer tax anonymity.

Answer: TRUE

Diff: 2

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

13) Eurobonds are usually issued in registered form.

Answer: FALSE

Diff: 1

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

14) Moody's assesses the investor's risk caused by changing exchange rates in the investment.

Answer: FALSE

Diff: 1

L.O.: 14.6 Raising Debt Globally

Skill: Recognition

AACSB: Application of knowledge

15) The Euro-medium-term-note (EMTN) has filled a substantial niche market in global

financing. What are the distinguishing characteristics of the EMTN and why is it such a popular

form of financing for MNEs?

Answer: EMTNs have maturity between the long-lived international bonds and the short-term

Euro-commercial paper, thus they have an appealing time horizon to many investors. EMTNs are

like international bonds in that they pay periodic interest. The distinguishing features of an

EMTN are: They are similar to a shelf registration in that the entire order for the securities does

not have to be issued on the same day. Coupon payments are paid continuously, and the

relatively small denominations allow for some flexibility in the market.

Diff: 3

L.O.: 14.6 Raising Debt Globally

Skill: Conceptual

AACSB: Application of knowledge

14.7 Financing Foreign Subsidiaries

1) External sources of financing available for foreign subsidiaries include all of the following

EXCEPT:

A) debt from the parent's country.

B) debt from countries outside the parent's country.

C) local or global equity.

D) intercompany and intracompany loans.

Answer: D

Diff: 2

L.O.: 14.7 Financing Foreign Subsidiaries

Skill: Recognition

AACSB: Application of knowledge

2) The financial structure and financing of a foreign subsidiary change over time as it passes

through the following stages of its business life cycle EXCEPT:

A) maturing.

B) growth.

C) startup.

D) discovery.

Answer: D

Diff: 2

L.O.: 14.7 Financing Foreign Subsidiaries

Skill: Recognition

AACSB: Application of knowledge

3) Internal financing includes all potential sources of fund arising from the MNE itself.

Answer: TRUE

Diff: 1

L.O.: 14.7 Financing Foreign Subsidiaries

Skill: Recognition

AACSB: Application of knowledge

4) External financing includes debt from any source that is not the MNE itself and equity from

any potential partner.

Answer: TRUE

Diff: 1

L.O.: 14.7 Financing Foreign Subsidiaries

Skill: Recognition

AACSB: Application of knowledge

5) In early stages of a foreign subsidiary's life, local host country debt is the only possible source

of funding.

Answer: FALSE

Diff: 1

L.O.: 14.7 Financing Foreign Subsidiaries

Skill: Recognition

AACSB: Application of knowledge

6) Multinationals often strive to maximize the amount of equity from the parent company in

foreign subsidiaries in order to reduce capital risk.

Answer: FALSE

Diff: 1

L.O.: 14.7 Financing Foreign Subsidiaries

Skill: Recognition

AACSB: Application of knowledge

7) Host country government would, in the extreme, prefer all inward investment be financed with

local debt.

Answer: FALSE

Diff: 1

L.O.: 14.7 Financing Foreign Subsidiaries

Skill: Recognition

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 15 Multinational Tax Management

15.1 Tax Principles and Practices

1) The issue of ethics in the reporting of income and the payment of taxes is a considerable one.

The authors state that most MNEs operating in foreign countries tend to follow the general

principle of:

A) "when in Rome, do as the Romans do."

B) full disclosure to the tax authorities.

C) maintain a competitive playing field by cheating as much as the local competition, no more,

no less.

D) none of the above

Answer: B

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

2) Which of the following is an unlikely objective of U.S. government policy for the taxation of

foreign MNEs?

A) to raise revenues

B) to provide an incentive for U.S. private investment in developing countries

C) to improve the U.S. balance of payments

D) All of the above are objectives.

Answer: D

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

3) A ________ tax policy is one that has no impact on private decision-making, while a

________ policy is designed to encourage specific behavior.

A) flat; tax incentive

B) neutral; flat tax

C) neutral; tax incentive

D) none of the above

Answer: C

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

4) Which of the following is NOT an example of a tax incentive policy?

A) The federal government gives a tax credit to MNEs that make domestic capital improvements

but not foreign capital improvements.

B) Corporations are allowed to take a direct tax credit for each dollar of matching donations they

make to institutions of higher education.

C) A tax law is passed that makes interest on property non-tax-deductible, but interest payments

on durable goods are.

D) All are examples of a tax incentive policy.

Answer: D

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

5) Toyota Motor Company operates in many different countries and pays taxes at many different

rates. However, they always pay the same rate as their local competitors. Toyota Motor

Company is operating in an environment of ________ tax policy.

A) domestic neutrality

B) foreign neutrality

C) territorial approach

D) none of the above

Answer: B

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

6) The United States taxes the domestic and remitted foreign earnings of U.S. based MNEs no

matter where the earnings occurred. This is an example of a/an ________ approach to levying

taxes.

A) worldwide

B) territorial

C) neutral

D) equitable

Answer: A

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

7) The United States taxes all earnings on U.S. soil by both domestic and foreign firms. This is

an example of a ________ approach to levying taxes.

A) worldwide

B) neutral

C) territorial

D) none of the above

Answer: C

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

8) Bacon Signs Inc. is based in a country with a territorial approach to taxation but generates

100% of its income in a country with a worldwide approach to taxation. The tax rate in the

country of incorporation is 25%, and the tax rate in the country where they earn their income is

50%. In theory, and barring any special provisions in the tax codes of either country, Bacon

should pay taxes at a rate of ________ in the country of incorporation.

A) 75%.

B) 62.5%.

C) 0%.

D) 50%.

Answer: C

Diff: 3

L.O.: 15.1 Tax Principles and Practices

Skill: Analytical

AACSB: Analytical thinking

9) The territorial approach to taxation policy is also termed the ________ approach.

A) source

B) ethical

C) greedy

D) location

Answer: A

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

10) A tax that is effectively a sales tax at each stage of production is defined as a/an ________

tax.

A) flat

B) equitable

C) value-added tax

D) none of the above

Answer: C

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

11) What is the total value of taxes paid in the following example if the value added tax is 10%?

A farmer raises wheat that he sells for $1.50 to the grain company. The grain company sells to

the processor for $2.00 per bushel. The processor turns the wheat into a breakfast cereal and

wholesales it for $3.00 per bushel. The retailer sells the cereal for $4.00 per bushel.

A) $0.15

B) $0.20

C) $0.30

D) $0.40

Answer: D

Diff: 3

L.O.: 15.1 Tax Principles and Practices

Skill: Analytical

AACSB: Analytical thinking

12) A tax that is a form of social redistribution of income is defined as a/an ________ tax.

A) un-American

B) transfer

C) flat

D) none of the above

Answer: B

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

13) Tax treaties typically result in ________ between the two countries in question.

A) lower property taxes for U.S. citizens overseas

B) elimination of differential tax rates

C) increased double taxation

D) reduced withholding tax rates

Answer: D

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

14) The primary objective of multinational tax planning is to minimize the firm's worldwide tax

burden.

Answer: TRUE

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

15) A country CANNOT have both a territorial and a worldwide approach as a national tax

policy.

Answer: FALSE

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

16) Tax treaties generally have the effect of increasing the withholding taxes between the

countries that are negotiating the treaties.

Answer: FALSE

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

17) A value-added tax has gained widespread usage in Western Europe, Canada, and parts of

Latin America.

Answer: TRUE

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

18) All indications are that the value-added tax will soon be the dominant form of taxation in the

U.S.

Answer: FALSE

Diff: 1

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

19) Among the G7 nations, the U.S. has a below average corporate income tax rate that makes it

attractive for other countries to invest in the U.S.

Answer: FALSE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

20) In the mid-1980s, the U.S. led the way to higher corporate income tax rates worldwide.

Today, most of the G7 nations have surpassed the U.S. and have higher corporate income tax

rates than the U.S.

Answer: FALSE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

21) The ideal tax should not only raise revenue efficiently but also have as few negative effects

on economic behavior as possible.

Answer: TRUE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

22) The worldwide approach, also referred to as the residential or national approach to tax

policy, levies taxes on the income earned by firms that are incorporated in the host country,

regardless of where the income was earned (domestically or abroad).

Answer: TRUE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

23) The territorial approach, also referred to as the source approach to tax policy, levies taxes on

the income earned by firms that are incorporated in the host country, regardless of where the

income was earned (domestically or abroad).

Answer: FALSE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

24) Of the OECD 30 countries, most employ a worldwide approach to tax policy, but a few,

including the United States, use the worldwide approach.

Answer: TRUE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

25) FEW governments rely on income taxes, both personal and corporate, for their primary

revenue source.

Answer: FALSE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

26) Between 2006-2012, global corporate tax rates have trended upward.

Answer: FALSE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

27) Tax treaties typically result in reduced withholding tax rates between the two signatory

countries.

Answer: TRUE

Diff: 2

L.O.: 15.1 Tax Principles and Practices

Skill: Recognition

AACSB: Application of knowledge

28) Explain the worldwide and territorial approaches of national taxation. The authors state that

the United States uses both approaches. How can this be? Give an example of each taxation

approach.

Answer: The worldwide approach taxes the income of firms based on their place of residence

rather than on where the income was earned. Thus, a U.S. based MNE will owe U.S. taxes on

income earned in, say, Britain. The territorial approach to taxation taxes all of the income earned

within the borders of the country by both domestic and foreign-based firms. Thus, a British-

based firm making sales in New York will owe taxes in the U.S.

Through a series of bilateral tax agreements, the U.S. and several trading partners have tried to

workout tax issues. Generally, the taxes a U.S. based MNE pays abroad will help offset any

required taxes the firm might have on funds remitted to the United States.

Diff: 3

L.O.: 15.1 Tax Principles and Practices

Skill: Analytical

AACSB: Analytical thinking

29) What is a value-added tax? Where is this type of tax in wide usage? Why do you suppose

this form of taxation has NOT been widely accepted in the United States?

Answer: A value-added tax (VAT) is a form of national sales tax, where goods are taxed at each

step of extraction, production, wholesale, and retail. A VAT tax is considered regressive because

those with lower incomes pay the same taxes on a particular commodity as those with more

money. Americans have never taken to this type of national tax because the most similar type of

state and local tax is the sales tax, and that has always been the domain of the states. Plus the fact

that it is regressive make the tax a tough sell to taxpayers.

Diff: 3

L.O.: 15.1 Tax Principles and Practices

Skill: Conceptual

AACSB: Application of knowledge

15.2 Multinational Tax Management

TABLE 15.1

Use the information to answer following question(s).

BayArea Designs Inc., located in Northern California, has two international subsidiaries, one

located in the Ukraine, the other in Korea. Consider the information below to answer the next

several questions.

1) Refer to Table 15.1. If BayArea pays out 50% of its earnings from each subsidiary, what are

the additional U.S. taxes due on the foreign sourced income from the Ukraine and Korea

respectively?

A) Ukraine = $0; Korea = ($30,000)

B) Ukraine = $100,000; Korea = $0

C) Ukraine = $0; Korea = $66,250

D) none of the above

Answer: D

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

2) Refer to Table 15.1. The additional U.S. taxes due on the repatriation of income from the

Ukraine to the United States, alone, assuming a 50% payout rate, is:

A) excess foreign tax credits of $110,000.

B) additional U.S. taxes due of $97,000.

C) additional U.S. taxes due of $36,500.

D) excess foreign tax credits of $18,500.

Answer: A

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

3) Refer to Table 15.1. How much in additional U.S. taxes would be due if BayArea averaged

the tax credits and liabilities of the two foreign units, assuming a 50% payout rate from each?

A) $3,750

B) $13,750

C) $2,500

D) $0

Answer: C

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

4) Refer to Table 15.1. If BayArea set the payout rate from the Ukraine subsidiary at 25%, how

should BayArea set the payout rate of the Korean subsidiary (approximately) to more efficiently

manage its total foreign tax bill?

A) 28.5%

B) 24.5%

C) 42.6%

D) 82.3%

Answer: B

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

5) Refer to Table 15.1. What is the minimum effective tax rate that BayArea can achieve on its

foreign-sourced income?

A) 26%

B) 35%

C) 40%

D) 0%

Answer: B

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

6) A ________ is a direct reduction of taxes whereas a ________ reduces the taxable income

before taxes.

A) foreign tax credit; domestic tax credit

B) tax deduction; tax credit

C) tax credit; tax deduction

D) none of the above

Answer: C

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

Instruction 15.2:

Use the information to answer the following question(s).

Green Valley Exporters USA has $100,000 of before-tax foreign income. The host country has a

corporate income tax rate of 25% and the U.S. has a corporate income tax rate of 35%.

7) Refer to Instruction 15.2. If the U.S. has no bilateral trade agreement with the host country,

what is the total amount of income taxes Green Valley Exporters will pay?

A) $25,000

B) $35,000

C) $51,250

D) $60,000

Answer: C

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

8) Refer to Instruction 15.2. If the U.S. has a bilateral trade agreement with the host country that

calls for the total tax paid to be equal to the maximum amount that could be paid in the highest

taxing country, what is the total amount of income taxes Green Valley Exporters will pay to the

host country, and how much will they pay in U.S income taxes on the foreign earned income?

A) $25,000; $10,000

B) $25,000; $26,250

C) $35,000; $0

D) none of the above

Answer: A

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

9) Refer to Instruction 15.2. If the U.S. treated the taxes paid on income earned in the host

country as a tax-deductible expense, then Green Valley's total U.S. corporate tax on the foreign

earnings would be:

A) $10,000.

B) $26,250.

C) $35,000.

D) $51,250.

Answer: B

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

10) Refer to Instruction 15.2. If the U.S. treated the taxes paid on income earned in the host

country as a tax-credit, then Green Valley's total U.S. corporate tax on the foreign earnings

would be:

A) $51,250.

B) $35,000.

C) $26,250.

D) $10,000.

Answer: D

Diff: 3

L.O.: 15.2 Multinational Tax Management

Skill: Analytical

AACSB: Analytical thinking

11) Transfer pricing is a strategy that may be used by MNEs to:

A) reduce consolidated corporate income taxes.

B) partially finance a subsidiary in another country.

C) transfer funds from a subsidiary to the parent corporation.

D) all of the above

Answer: D

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

12) ________ is the pricing of goods, services, and technology between related companies.

A) Among pricing

B) Retail pricing

C) Transfer pricing

D) Wholesale pricing

Answer: C

Diff: 1

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

13) Tax-haven subsidiaries are typically established in a country that can meet the following

requirements:

A) a low tax on foreign investment or sales income earned by resident corporations and a low

dividend withholding tax on dividends paid to the parent firm.

B) the facilities to support financial services, for example, good communications, professional

qualified office workers, and reputable banking services.

C) a stable government that encourages the establishment of foreign-owned financial and service

facilities within its borders.

D) all of the above

Answer: D

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

14) The rapid evolution of corporate inversions for U.S.-based multinationals over the past 20

years has been attributed to all of the following EXCEPT:

A) lack of foreign tax credits.

B) relatively high U.S. corporate tax rate.

C) U.S. lack of global competitiveness.

D) the worldwide tax principles.

Answer: A

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

15) Of the following, which is NOT cited by the authors as an example of tax haven?

A) Ireland

B) Bermuda

C) Cayman Islands

D) Bahamas

Answer: A

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

16) Tax credits are less valuable on a dollar-for-dollar basis than are tax-deductible expenses.

Answer: FALSE

Diff: 1

L.O.: 15.2 Multinational Tax Management

Skill: Conceptual

AACSB: Application of knowledge

17) The U.S. Internal Revenue Service can reallocate revenues and expenses between parent

corporations and their subsidiaries to more clearly reflect a proper allocation of income. In such

instances it is the responsibility of the corporation to prove that the IRS has been arbitrary in its

decision-making, thus establishing a "guilty until proved innocent" tax approach.

Answer: TRUE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

18) When a firm is organized with decentralized profit centers, transfer pricing between centers

can help in the evaluation of each subsidiary performance.

Answer: FALSE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

19) If a U.S. multinational remits profits from two different countries (subsidiaries) back to the

parent company (U.S.), the excess foreign tax credit from one subsidiary can only be cross-

credited against another subsidiary from the same country.

Answer: FALSE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

20) Tax haven subsidiaries of MNEs are categorically referred to as international offshore

financial centers.

Answer: TRUE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

21) Maximizing local profits in joint ventures overseas could be suboptimal from the overall

view of the MNE.

Answer: TRUE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

22) In a typical naked corporate inversion transaction, the corporation's effective global tax

liability is reduced, but the effective control does not change.

Answer: TRUE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

23) The 80% rule added in the American Jobs Creation Act (AJCA) of 2004 makes less likely

that the former parent company would continue to be treated as domestic.

Answer: FALSE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

24) One case of inversion is when a U.S. company is merged with a large foreign firm and the

new combined entity is incorporated in the foreign country. The added stipulation to be a valid

inversion is that the previous U.S. ownership must have a position of less than 80% ownership in

the new combined entity.

Answer: FALSE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

25) Finance ministers of the G20 in conjunction with the OECD created an action plan to stop

basis erosion and profit shifting (BEPS) in an effort to stop illegal activity.

Answer: FALSE

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Recognition

AACSB: Application of knowledge

26) What is a transfer price, and can a government regulate it? What difficulties and motives

does a parent multinational firm face in setting transfer prices?

Answer: A transfer price is the amount paid by one unit of a company (domestic or

international) for goods or services purchased from another unit of the same firm. As such, a

transfer price is needed for every intrafirm transaction. Where buyer and seller are in different

tax jurisdictions (i.e., countries), governments are concerned with the possibility that transfer

prices are raised or lowered from a "normal" or "appropriate" level in order to avoid taxes. In

most countries tax authorities have the right to declare a given international transfer price as a tax

avoidance device. Such countries have the right to reset taxable income to a higher level. The

motives for the parent MNE are to minimize taxes, and the difficulty is that the burden of proof

is on the MNE, not the tax collector, to show proof as to why a given transfer price is reasonable.

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Conceptual

AACSB: Application of knowledge

27) What are the desired characteristics for a country if it expects to be used as a tax haven?

Answer: Tax-haven subsidiaries are typically established in a country that can meet the

following requirements: 1) A low tax on foreign investment or sales income earned by resident

corporations and a low dividend withholding tax on dividends paid to the parent firm. 2) A stable

currency to permit easy conversion of funds into and out of the local currency. 3) The facilities to

support financial services: good communications, professional qualified office workers, and

reputable banking services. 4) A stable government that encourages the establishment of foreign-

owned financial and service facilities within its borders.

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Conceptual

AACSB: Application of knowledge

28) Why do the U.S. tax authorities tax passive income generated offshore differently from

active income?

Answer: One type of passive income would simply be the distributed profits of another

company, dividends, if the foreign company owned it. Without the differential treatment, it

would only make sense for most U.S. multinationals to create a holding company in a tax haven,

which would then own all the foreign subsidiaries of the company. Then, all the profits earned by

the Holding Company would be retained in a low tax environment without incurring any U.S. tax

liabilities.

Diff: 2

L.O.: 15.2 Multinational Tax Management

Skill: Conceptual

AACSB: Application of knowledge

15.3 Google: An Illustrative Case of Profit Repositioning

1) Why is it core to Google's tax planning to fix a tax base (also known as permanent

establishment) in Ireland?

Answer: Permanent establishment rules allow firms such as Google to fix a tax base in a low-

tax country like Ireland, while generating lots of business in a country where tax rates are higher,

like France. Companies in principle are taxed not on "where they do business," but on "where

they finalize their business deals with customers" —the country or jurisdiction where the final

contract is signed. In the case of Google, that means most sales throughout the European Union

are finalized in Ireland. It is estimated that 75% of the top 50 U.S. software, Internet, and

computer hardware companies use similar PE structures that help them avoid taxes.

Diff: 2

L.O.: 15.3 Google: An Illustrative Case of Profit Repositioning

Skill: Conceptual

AACSB: Application of knowledge

15.4 Global Tax Competitiveness

1) The changing global tax environment for multinational firms has been attributed to all of the

following EXCEPT:

A) rapid expansion of the global digital economy.

B) aggressiveness of governments to increase their individual tax competitiveness.

C) increase cost of capital.

D) all of the above

Answer: C

Diff: 2

L.O.: 15.4 Global Tax Competitiveness

Skill: Conceptual

AACSB: Application of knowledge

2) Governments worldwide compete for global investment on all of the following grounds

EXCEPT:

A) availability of skilled labor.

B) labor cost.

C) regulatory requirements.

D) all of the above

Answer: D

Diff: 2

L.O.: 15.4 Global Tax Competitiveness

Skill: Conceptual

AACSB: Application of knowledge

3) In the context of the digital economy many tax authorities are redefining the location of a

taxable transaction from the county of the supplier to the country of the buyer.

Answer: TRUE

Diff: 1

L.O.: 15.4 Global Tax Competitiveness

Skill: Recognition

AACSB: Application of knowledge

4) All the OECD countries depend on individual income taxes for a very large part of their tax

proceeds.

Answer: FALSE

Diff: 1

L.O.: 15.4 Global Tax Competitiveness

Skill: Recognition

AACSB: Application of knowledge

5) Tax analysts and authorities believe that in the years ahead most of the world will move

towards increased use of direct taxes — income taxes.

Answer: FALSE

Diff: 1

L.O.: 15.4 Global Tax Competitiveness

Skill: Recognition

AACSB: Application of knowledge

15.5 U.S. Tax Law Change in 2017

1) The Act of 2017 has multiple provisions; the following are likely of the most significant to all

U.S. companies EXCEPT:

A) U.S. corporate income tax rate is reduced to 21%.

B) Limits the net interest deductions.

C) Allows companies to deduct the entire cost of equipment purchases from their taxable

income.

D) all of the above

Answer: D

Diff: 2

L.O.: 15.5 U.S. Tax Law Change in 2017

Skill: Conceptual

AACSB: Application of knowledge

2) As part of the Act of 2017, the taxation of Foreign-Source Income will not create tax credits

or deficits when declared as dividends to the U.S. parent.

Answer: TRUE

Diff: 1

L.O.: 15.5 U.S. Tax Law Change in 2017

Skill: Recognition

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 16 International Trade Finance

16.1 The Trade Relationship

1) The exporter-importer relationship to a corporation of a foreign importer that has not

previously conducted business with the firm would be an:

A) unaffiliated known.

B) affiliated party.

C) unaffiliated unknown.

D) any of the above

Answer: C

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following relationships between importing and exporting parties would require

the least detailed contract to conduct business?

A) affiliated party

B) unaffiliated unknown party

C) known unaffiliated party

D) domestic supplier

Answer: B

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

3) Polaris Corporation has made an agreement to ship goods to a foreign firm with whom they

have not entered into a contract for three years. However, the firms have communicated regularly

since the last sale three years ago. This is an example of an:

A) unaffiliated known party transaction.

B) unaffiliated unknown party transaction.

C) affiliated party transaction.

D) none of the above

Answer: A

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Conceptual

AACSB: Application of knowledge

4) Which of the following is NOT a financial instrument that may be included in an international

trade transaction?

A) Letter of Credit

B) Sight Draft

C) Order bill of lading

D) Federal funds transaction

Answer: D

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

5) The combination of a letter of credit, a sight draft, and an order bill of lading protect both

parties in international transactions from which of the following?

A) the risk of noncompletion

B) the risk of foreign exchange risk (when combined with a various hedging techniques)

C) the risk that financing will not be available due to foreign exchange risk

D) All of these risks are reduced when using these trade implements.

Answer: D

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

6) The risk of noncompletion is most important:

A) when the international trade is recurrent in nature.

B) when there is a sustained relationship between the buyer and seller.

C) with an outstanding agreement for recurring shipments.

D) when the relationship is between countries whose currencies are considered strong.

Answer: D

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

7) From a financial management perspective, all of the following are primary risks associated

with an international trade transaction EXCEPT:

A) currency risk.

B) default risk.

C) noncompletion risk.

D) interest rate risk.

Answer: D

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

8) The risk of default on the part of the importer—risk of noncompletion—is present as soon as:

A) a price quote is given.

B) goods are received.

C) the export contract is signed.

D) the financing period begins.

Answer: D

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Conceptual

AACSB: Application of knowledge

9) Today, international trade is dominated by transactions between unaffiliated parties (known or

unknown).

Answer: FALSE

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

10) Because most international transactions are between affiliated parties, international

transaction contracts are less complex, but the management of the total value of the MNE is

more complex.

Answer: TRUE

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

11) An advantage of trading with an affiliated party for an MNE, compared to an unaffiliated

party, could be reduced contracting costs and less to even no need to protect against nonpayment.

Answer: TRUE

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

12) The fundamental dilemma of foreign trade is being unwilling to trust a stranger in a foreign

land.

Answer: TRUE

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

13) If a foreign exchange transaction calls for payment in the importer's currency, the exporter

has the foreign exchange risk.

Answer: TRUE

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

14) If a foreign exchange transaction calls for payment in the exporter's currency, the importer

has the foreign exchange risk.

Answer: TRUE

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

15) In the case of international trade, the risk of nonpayment is essentially eliminated with the

use of a letter of credit issued through a trustworthy bank.

Answer: TRUE

Diff: 1

L.O.: 16.1 The Trade Relationship

Skill: Recognition

AACSB: Application of knowledge

16) Why might different documentation be used for an export to a nonaffiliated foreign buyer

who is a new customer, as compared with an export to a nonaffiliated foreign buyer to whom the

exporter has been selling for many years?

Answer: A new nonaffiliated buyer presents a credit risk for the exporter, because the exporter

may be unable to assess the creditworthiness of that importer due to geographic distance,

language, culture, or lack of a record of payments to other suppliers. A letter of credit,

accompanied by other documents, allows the exporter to rely on the credit standing of a bank,

which is presumed to be of greater creditworthiness than just an unknown manufacturing firm.

After successful trade goes on for some time the importer becomes a known entity, in which case

the exporter will have more faith in the importer's willingness and ability to pay. Because the

letter of credit and other documents have both a financial cost and a cost for the time and energy

involved in handling the documents, direct billing for exports is easier, faster, and lowers the

final end-cost to the ultimate customer.

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Conceptual

AACSB: Application of knowledge

17) For what reason might an exporter use standard international trade documentation (letter of

credit, draft, order bill of lading) on an intrafirm export to its parent or sister subsidiary?

Answer: An export to a parent or sister subsidiary has no credit risk because both exporter and

importer are part of the same corporate unit. Non-payment to an exporter in this situation is just a

matter of keeping the firm's cash in another corporate account. In fact, very late payment for an

export to an affiliated importer might be desirable, because the firm wants to keep cash in one

location and not in another. Nevertheless, an export to an affiliated buyer might pass through the

standard documentation as a way to obtain financing that is easy to obtain, is possibly cheaper

than alternative sources of short-term financing, or provides some protection against political or

country-based interruption to payment for the transaction.

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Conceptual

AACSB: Application of knowledge

18) What is the major difference between "currency risk" and "risk of noncompletion"? How are

these risks handled in a typical international trade transaction?

Answer: Currency risk is the risk that the currency designated for payment of the import

changes in value relative to the other currency. A U.S. firm exporting to France wants dollars,

while the French importer wants to pay euros. If the sale contract specifies payment in dollars,

the French importer has a currency risk—more euros than expected might be needed when

payment is due. If the sales contract specifies payment in euros, the U.S. exporter has a currency

risk—fewer dollars than expected might be received when the euros are exchanged for dollars.

Risk of noncompletion is the risk that one of the parties fails to fulfill its obligations. The

importer may refuse to pay for the goods, or the exporter may fail to ship the goods. Events not

under the control of the parties to the trade, such as major storms, disease epidemics, terrorist

acts, or war, may make completion of the trade impossible. The several documents involved in

international trade are intended to reduce financial loss from noncompletion.

Diff: 2

L.O.: 16.1 The Trade Relationship

Skill: Conceptual

AACSB: Application of knowledge

16.2 Key Documents

1) Which of the following is NOT true regarding a letter of credit?

A) The importer and exporter agree on a transaction.

B) The importer applies to its local bank for the issuance of a letter of credit.

C) The exporter applies to its local bank for the issuance of a letter of credit.

D) The importer's bank cuts a sales contract based on its assessment of the creditworthiness of

the importer.

Answer: C

Diff: 2

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

2) A/An ________ letter of credit is intended to serve as a means of arranging payment, but not

as a guarantee of payment.

A) irrevocable

B) revocable

C) confirmed

D) unconfirmed

Answer: B

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

3) A/An ________ letter of credit is an obligation only of the issuing bank whereas other banks

honor a/an ________ letter of credit.

A) irrevocable; unconfirmed

B) revocable; confirmed

C) confirmed; irrevocable

D) unconfirmed; confirmed

Answer: D

Diff: 2

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

4) A letter of credit that is confirmed in the ________ country has the additional advantage of

eliminating the problem of ________.

A) exporter's; portfolio risk

B) importer's; blocked foreign exchange

C) exporter's; blocked foreign exchange

D) none of the above

Answer: C

Diff: 2

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

5) The draft is the instrument normally used in international commerce to:

A) transfer product.

B) prove ownership.

C) transfer title.

D) initiate the sale.

Answer: C

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

6) The ________ is the instrument normally used to actually effect payment in international

commerce.

A) banker's acceptance

B) bill of exchange

C) bill of lading

D) letter of credit

Answer: B

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

7) The person or company initiating the draft or bill of exchange is known as the:

A) maker.

B) drawer.

C) originator.

D) any of the above

Answer: D

Diff: 2

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

8) The person or company to whom the draft or bill of exchange is addressed is the:

A) drawee.

B) drawer.

C) maker.

D) originator.

Answer: A

Diff: 2

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

9) Drafts that have been accepted by banks become:

A) clean drafts.

B) nonmarketable.

C) banker's acceptances.

D) none of the above

Answer: C

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

10) Which of the following purposes is NOT served by the bill of lading?

A) It acts as a receipt.

B) It acts as a contract.

C) It acts as a document of title.

D) It acts as all of the above.

Answer: D

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

11) The ________ is issued to the exporter by a common carrier transporting the merchandise.

A) bill of lading

B) draft

C) banker's acceptance

D) line of credit

Answer: A

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

12) A straight bill of lading is most likely to be used under which of the following

circumstances?

A) when the merchandise has not been paid for in advance

B) when the transaction is being financed by a bank

C) when the shipment is to an affiliate

D) none of the above

Answer: C

Diff: 2

L.O.: 16.2 Key Documents

Skill: Conceptual

AACSB: Application of knowledge

13) To become a negotiable instrument, a draft must conform to the following requirements

EXCEPT:

A) it must be in writing and signed by the maker or drawer.

B) it must be payable to order or to bearer.

C) it must be written in English.

D) it must be payable on demand or at a fixed or determinable future date.

Answer: C

Diff: 2

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

14) In a typical international trade transaction, the order of activity would be which of the

following?

A) The foreign buyer places an order; The domestic manufacturer ships to the buyer; The

manufacturer's bank presents a draft and documents to the buyer's bank for acceptance; The

buyer's bank submits payment to the manufacturer's bank.

B) The domestic manufacturer ships to the buyer; The buyer's bank submits payment to the

manufacturer's bank; The foreign buyer places an order; The domestic manufacturer ships to the

buyer; The manufacturer's bank presents a draft and documents to the buyer's bank for

acceptance.

C) The foreign buyer places an order; The manufacturer's bank presents a draft and documents to

the buyer's bank for acceptance; The domestic manufacturer ships to the buyer; The buyer's bank

submits payment to the manufacturer's bank.

D) The domestic manufacturer ships to the buyer; The manufacturer's bank presents a draft and

documents to the buyer's bank for acceptance; The foreign buyer places an order; The buyer's

bank submits payment to the manufacturer's bank.

Answer: A

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

15) A letter of credit is an agreement by the bank to pay against documents rather than the actual

merchandise.

Answer: TRUE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

16) The primary advantage of a letter of credit is that it reduces risk.

Answer: TRUE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Conceptual

AACSB: Application of knowledge

17) The major advantage of a letter of credit to the exporter is that the exporter does not receive

any funds until the documents have arrived at a local port or airfield.

Answer: FALSE

Diff: 2

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

18) To constitute a true letter of credit transaction, the issuing bank must receive a fee or other

valid business consideration for issuing the L/C.

Answer: TRUE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

19) To constitute a true letter of credit transaction, the bank's L/C must contain a specified

expiration date or a definite maturity.

Answer: TRUE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

20) To constitute a true letter of credit transaction, the bank's commitment must be open-ended

and cannot have a stated maximum amount of money.

Answer: FALSE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

21) A revocable L/C is intended to serve as a means of arranging payment but not as a guarantee

of payment.

Answer: TRUE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

22) A sight draft is payable on presentation to the drawee; a time draft allows a delay in

payment.

Answer: FALSE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

23) A draft is sometimes called a revocable letter of credit.

Answer: FALSE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

24) A time draft is payable on presentation to the drawee; the drawee must pay at once or

dishonor the draft. A sight draft, allows a delay in payment.

Answer: FALSE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Conceptual

AACSB: Application of knowledge

25) The bill of lading is issued to the exporter by a common carrier transporting the merchandise.

It serves three purposes: a receipt, a contract, and a document of title.

Answer: TRUE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

26) Because of the risks involved in international trade, most transactions follow conventional

methods and rarely require flexibility or creativity on the part of management.

Answer: FALSE

Diff: 1

L.O.: 16.2 Key Documents

Skill: Recognition

AACSB: Application of knowledge

27) Explain what a letter of credit (L/C) is, who the principle parties are, what the principle

advantage is, and how the L/C facilitates international trade.

Answer: A letter of credit (L/C) is a bank's conditional promise to pay issued by a bank at the

request of an importer. The primary advantage of an L/C is the reduction in risk. This reduction

in risk makes it easier for the exporter to sell goods to the importer because it no longer need rely

on the ability of the importing firm to pay for the goods, but rather it can rely on the bank.

There are three primary parties involved with a letter of credit. Party number one is the exporter,

who makes a sale to the importer in exchange for the bank's L/C. Party number two is the

importer who receives the goods and promises to pay the bank. And third, the bank that contracts

with the importer and agrees to pay the exporter upon presentation of documents as specified in

the L/C.

The advantage to an exporter is the increased likelihood of receiving payment because funds are

due from a known international commercial bank as opposed to a relatively unknown importer.

Furthermore, an exporter with a good reputation for delivery may be able to sell the L/C at a

discount in the secondary market prior to shipping and speed up cash flow.

The importer benefits because it doesn't need to pay for goods purchased until they actually

reach port. The bank benefits from the fees they charge.

Diff: 3

L.O.: 16.2 Key Documents

Skill: Conceptual

AACSB: Application of knowledge

16.3 Government Programs to Help Finance Exports

1) The Export-Import Bank is an independent agency of the U.S. government established in 1934

to:

A) ship money abroad.

B) import agricultural products during the recession.

C) facilitate and stimulate foreign trade of the United States.

D) none of the above

Answer: C

Diff: 2

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

2) In the United States, the Foreign Credit Insurance Corporation:

A) is a subsidiary of the Export-Import Bank.

B) provides letters of credit for U.S. importers.

C) provides letters of credit for U.S. exporters.

D) provides policies that protect U.S. exporters against default by foreign importers.

Answer: D

Diff: 2

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

3) The Eximbank does all of the following EXCEPT:

A) guarantees lease transactions.

B) supplies counseling for exporters in finding financing for U.S. goods.

C) finances the cost involved in the preparation of feasibility studies for non-U.S. clients

D) provides letters of credit for U.S. exporters.

Answer: D

Diff: 2

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

4) The Foreign Credit Insurance Association is a branch of the U.S. federal government.

Answer: FALSE

Diff: 1

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

5) The Export-Import Bank (also called Eximbank) is an independent agency of the U.S.

government, established in 1934 to stimulate and facilitate the foreign trade of the United States.

Answer: TRUE

Diff: 1

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

6) Essentially, the Eximbank lends dollars to borrowers inside the United States for the purchase

of U.S. goods and services.

Answer: FALSE

Diff: 1

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

7) In the United States, domestic taxpayers bear the cost of export credit insurance and export

financing provided by institutions like the FCIA and Eximbank to foreign buyers in order to

create employment and maintain a technological edge.

Answer: TRUE

Diff: 1

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

8) Export credit insurance provides assurance to the exporter or the exporter's bank that, should

the foreign customer default on payment, the insurance company will pay for a major portion of

the loss.

Answer: TRUE

Diff: 1

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

9) One way a nation can improve its exports is by shortening the period for which credit

transactions can be insured.

Answer: FALSE

Diff: 1

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

10) The European Union recommends maximum credit terms for many items including, for

example, heavy capital goods (five years), light capital goods (three years), and consumer

durable goods (one year).

Answer: FALSE

Diff: 1

L.O.: 16.3 Government Programs to Help Finance Exports

Skill: Recognition

AACSB: Application of knowledge

16.4 Trade Financing Alternatives

Instruction 16.1:

Use the information to answer the following question(s).

Cypress Systems Inc., of Florida, agrees to sell specialized hydroponic growing equipment to

Landcaster's of Australia. Because the two companies have never done business with each other,

Cypress requires a banker's acceptance as payment for the $1,000,000 order. The banker's

acceptance carries a 1.4% commission per annum and payment is to be received in 6 months. If

Cypress Inc. chooses to discount or sell the banker's acceptance to its bank, the discount rate is

1.00% per annum.

1) Refer to Instruction 16.1. What is the size of the discount (not including the commission fee)

Cypress must take for receiving the proceeds of the sale today rather than waiting for six

months?

A) $7,000

B) $5,000

C) $12,000

D) $14.000

Answer: B

Diff: 3

L.O.: 16.4 Trade Financing Alternatives

Skill: Analytical

AACSB: Analytical thinking

2) Refer to Instruction 16.1. What is the size of the commission Cypress will pay the bank for the

banker's acceptance?

A) $7,000

B) $5,000

C) $12,000

D) $14,000

Answer: A

Diff: 3

L.O.: 16.4 Trade Financing Alternatives

Skill: Analytical

AACSB: Analytical thinking

3) Refer to Instruction 16.1. What is the total Cypress can expect to receive if the firm takes

payment today?

A) $993,000

B) $995,000

C) $988,000

D) $996,000

Answer: C

Diff: 3

L.O.: 16.4 Trade Financing Alternatives

Skill: Analytical

AACSB: Analytical thinking

4) Refer to Instruction 16.1. ________ is an unsecured promissory note.

A) A banker's acceptance

B) An overdraft

C) A securitized loan

D) Commercial paper

Answer: D

Diff: 3

L.O.: 16.4 Trade Financing Alternatives

Skill: Recognition

AACSB: Application of knowledge

5) Rogue Spices Inc. has a Canadian receivables contract for $200,000 due in 270 days. The firm

has been approached by a factoring firm that offers to purchase the receivables at a 12% per

annum discount plus a 1% charge for a nonrecourse clause. What is the annualized percentage

all-in-cost of this factoring alternative?

A) 14.82%

B) 13.00%

C) 12.00%

D) 9.09%

Answer: A

Diff: 3

L.O.: 16.4 Trade Financing Alternatives

Skill: Analytical

AACSB: Analytical thinking

6) Export receivables are normally sold at a discount. The size of the discount depends on the

following factors EXCEPT:

A) overdraft fees.

B) collection risk.

C) cost of credit insurance.

D) size of financing and services fees.

Answer: A

Diff: 3

L.O.: 16.4 Trade Financing Alternatives

Skill: Analytical

AACSB: Application of knowledge

7) Banker's acceptances are used to finance only international trade receivables but not domestic

trade receivables.

Answer: FALSE

Diff: 1

L.O.: 16.4 Trade Financing Alternatives

Skill: Recognition

AACSB: Application of knowledge

8) The first owner of the bankers' acceptance created from an international trade transaction will

be the importer, who receives the endorsed draft back after the bank has stamped it "accepted."

Answer: FALSE

Diff: 2

L.O.: 16.4 Trade Financing Alternatives

Skill: Recognition

AACSB: Application of knowledge

9) An overdraft agreement allows a firm to overdraw its bank account up to the limit of its credit

line.

Answer: TRUE

Diff: 2

L.O.: 16.4 Trade Financing Alternatives

Skill: Recognition

AACSB: Application of knowledge

10) Issuing commercial papers to finance accounts receivable or short-term financing needs lies

at the low end of the pecking order of trade financing alternatives.

Answer: FALSE

Diff: 2

L.O.: 16.4 Trade Financing Alternatives

Skill: Recognition

AACSB: Application of knowledge

11) Recourse means that the factor assumes the credit, political, and foreign exchange risk for

the receivables it purchases.

Answer: FALSE

Diff: 2

L.O.: 16.4 Trade Financing Alternatives

Skill: Recognition

AACSB: Application of knowledge

12) The firm selling the recourse receivables avoids the cost of determining the creditworthiness

of its customers.

Answer: FALSE

Diff: 2

L.O.: 16.4 Trade Financing Alternatives

Skill: Recognition

AACSB: Application of knowledge

13) What is a banker's acceptance? How are they initiated? Why are they desirable for the

exporter?

Answer: A draft, or bill of exchange, is a written order from the exporter telling the importer

when and how much to pay. When properly contracted, a draft can become a negotiable

instrument and trade in the secondary market. If the draft provides a specific payment date and is

presented to the importer's bank, it becomes a banker's acceptance (BA) and the bank makes an

unconditional promise to make payment upon maturity. A BA may sell in the secondary market

like any other marketable security and the holder need not wait until maturity to liquidate. Thus,

BAs facilitate trade by reducing risk and potentially speeding cash flows to the exporter.

Diff: 3

L.O.: 16.4 Trade Financing Alternatives

Skill: Conceptual

AACSB: Application of knowledge

16.5 Forfaiting: Medium- and Long-Term Financing

1) ________ is a specialized technique to eliminate the risk of nonpayment by importers in

instances where the importing firm and/or its government is perceived by the exporter to be too

risky for open account credit.

A) Forfeiting

B) Marketable Bank Shares

C) Forfaiting

D) Banker's Acceptances

Answer: C

Diff: 1

L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT true about forfaiting?

A) The exporter is responsible for the quality of delivered goods.

B) Exporter receives an unconditional cash payment at the time of the transaction.

C) The exporter sells bank-guaranteed promissory notes at its face value.

D) The political and commercial risk is carried by the guaranteeing bank.

Answer: C

Diff: 2

L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing

Skill: Recognition

AACSB: Application of knowledge

3) A typical forfaiting transaction involves the following parties EXCEPT:

A) importer.

B) exporter.

C) carrier.

D) importer's Bank.

Answer: C

Diff: 1

L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing

Skill: Recognition

AACSB: Application of knowledge

4) The following parties are usually guarantors in forfaiting EXCEPT:

A) commercial banks.

B) government ministries of finance.

C) large commercial enterprises.

D) government banks.

Answer: C

Diff: 1

L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing

Skill: Recognition

AACSB: Application of knowledge

5) In effect, the forfaiter functions both as a money market firm and a specialist in packaging

financial deals involving country risk.

Answer: TRUE

Diff: 1

L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing

Skill: Recognition

AACSB: Application of knowledge

6) Success of the forfaiting technique springs from the belief that the aval can be depended on.

Answer: TRUE

Diff: 1

L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing

Skill: Recognition

AACSB: Application of knowledge

7) The liability of the aval is an "on balance sheet" obligation for the endorsing bank.

Answer: FALSE

Diff: 1

L.O.: 16.5 Forfaiting: Medium- and Long-Term Financing

Skill: Recognition

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 17 Foreign Direct Investment and Political Risk

17.1 The Foreign Direct Investment Decision

1) Based on observations of firms that have successfully invested abroad, we can conclude that

one of the competitive advantages enjoyed by MNEs is:

A) managerial expertise.

B) financial strength.

C) competitiveness of their home markets.

D) All of the above are competitive advantages.

Answer: D

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

2) Based on observations of firms that have successfully invested abroad, we can conclude

companies are more competitive when:

A) facing sophisticated and demanding customers in the home market.

B) surrounded by a critical mass of related industries and suppliers.

C) located in countries that are naturally endowed with the appropriate factors of production.

D) All of the above are true.

Answer: D

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

3) The OLI paradigm is an attempt to create a framework to explain why MNEs choose

________ rather than some other form of international venture.

A) licensing

B) joint ventures

C) foreign direct investment

D) strategic alliances

Answer: C

Diff: 1

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

4) The O in OLI refers to an advantage in a firm's home market that is:

A) operator independent.

B) owner-specific.

C) open-market.

D) official designation.

Answer: B

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

5) The owner-specific advantages of OLI must be:

A) firm-specific.

B) not easily copied.

C) transferable to foreign subsidiaries.

D) all of the above

Answer: D

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

6) A/An ________ would be an example of an owner-specific advantage for an MNE.

A) patent

B) economy of scale

C) economy of scope

D) all of the above

Answer: A

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Conceptual

AACSB: Application of knowledge

7) The L in OLI refers to an advantage in a firm's home market that is a:

A) liability in the domestic market.

B) location-specific advantage.

C) longevity in a particular market.

D) none of the above

Answer: B

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

8) A/An ________ would be an example of a location-specific advantage for an MNE.

A) patent

B) economy of scale

C) unique source of raw materials

D) possession of proprietary information

Answer: C

Diff: 1

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Conceptual

AACSB: Application of knowledge

9) The I in OLI refers to an advantage in a firm's home market that is an:

A) internalization.

B) industry-specific advantage.

C) international abnormality.

D) none of the above

Answer: A

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

10) A/An ________ would be an example of an internalization advantage for an MNE.

A) patent

B) economy of scale

C) unique source of raw materials

D) possession of proprietary information

Answer: D

Diff: 1

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Conceptual

AACSB: Application of knowledge

11) In deciding whether to invest abroad, management must first determine whether the firm has

a sustainable competitive advantage that enables it to compete effectively in the home market.

The competitive advantage must be:

A) firm specific.

B) not easily copied.

C) in a transferable form.

D) all of the above

Answer: D

Diff: 1

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Conceptual

AACSB: Application of knowledge

12) Which of the following is NOT a market imperfection or genuine comparative advantage that

attracts FDI to particular locations?

A) low cost and productive labor force

B) unique sources of raw materials

C) defensive investments

D) an expansive monetary policy

Answer: D

Diff: 1

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Conceptual

AACSB: Application of knowledge

13) A strongly competitive home market tends to dull the competitive advantage relative to firms

located in less competitive home markets.

Answer: FALSE

Diff: 3

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

14) Reactive financial strategies can be formulated in advance by the MNE's financial managers.

Answer: FALSE

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

15) Proactive financial strategies depend on discovering market imperfections.

Answer: FALSE

Diff: 2

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Recognition

AACSB: Application of knowledge

16) List and explain three strategic motives why firms could become multinationals and give an

example of each.

Answer: The strategic motives for firms to become multinationals could be: market seekers, raw

materials seekers, production efficiency seekers, knowledge seekers, and political safety seekers.

Market seekers are looking for more consumers for their products such as automobiles, or steel.

Knowledge seekers may be looking for an educated workforce similar to the way firms seeking

R and D set up shop in university towns. Raw materials seekers may be after commodities such

as oil or copper. Production efficiencies may occur in countries like Mexico that have capable

workers and lower wages. Political safety seekers are looking for countries that will not

expropriate their assets, so they may stay away from countries that in the post have engaged in

such activities.

Diff: 3

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Conceptual

AACSB: Application of knowledge

17) What does the OLI Paradigm propose to explain? Define each component and provide an

example of each.

Answer: The OLI Paradigm is an attempt to develop an overall framework to explain why

MNEs choose FDI to serve foreign markets rather than alternatives such as licensing or

exporting. The letters of the paradigm are O for owner-specific advantages, L for location-

specific advantages, and I for internalization.

Owner-specific advantages require that the firm have a comparative advantage in its home

market that it feels it can exploit internationally. To be most effective, the advantages should be

difficult to copy. Location specific advantages may be due to market imperfections or genuine

comparative advantages such as a source of a particularly high quality natural resource. With

internalization the firm has in its possession some proprietary information or product such as

software or personnel that may provide an advantage in the international marketplace.

Diff: 3

L.O.: 17.1 The Foreign Direct Investment Decision

Skill: Conceptual

AACSB: Application of knowledge

17.2 Structural Choices for Foreign Market Entry

1) Which of the following is NOT true regarding behavioral observations of firms making a

decision to invest internationally?

A) MNEs initially invest in countries with a similar "national psychic."

B) Firms eventually take greater risks in terms of the national psychic of countries in which they

invest.

C) Initial investments tend to be much larger than subsequent ones.

D) All of the above have been observed.

Answer: C

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT an advantage to exporting goods to reach international

markets rather than entering into some form of FDI?

A) fewer political risks

B) greater agency costs

C) lower front-end investment

D) All of the above are advantages.

Answer: B

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

3) Which of the following is an advantage to exporting goods to reach international markets

rather than entering into some form of FDI?

A) fewer agency costs

B) fewer direct advantages from research and development

C) a greater risk of losing markets to copycat goods producers

D) an inability to exploit R&D as effectively as if also invested abroad

Answer: A

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

4) Which of the following is NOT a form of FDI?

A) wholly-owned affiliate

B) joint venture

C) exporting

D) greenfield investment

Answer: C

Diff: 1

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

5) With licensing the ________ is likely to be lower than with FDI because of lower profits;

however, the ________ is likely to be higher due to a greater return per dollar invested.

A) IRR; NPV

B) NPV; IRR

C) cost of capital; NPV

D) IRR; cost of capital

Answer: B

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

6) Which of the following is NOT a potential disadvantage of licensing relative to FDI?

A) possible loss of quality control

B) establishment of a potential competitor in third-country markets

C) possible improvement of the technology by the local licensee, which then enters the original

firm's home market

D) All of the above are potential disadvantages to licensing.

Answer: D

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

7) A ________ is a shared ownership in a foreign business.

A) licensing agreement

B) greenfield investment

C) joint venture

D) wholly-owned affiliate

Answer: C

Diff: 1

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

8) Which of the following is NOT an advantage to a joint venture?

A) Possible loss of opportunity to enter the foreign market with FDI later.

B) The local partner understands the customs and mores of the foreign market.

C) The local partner can provide competent management at many levels.

D) May be a realistic alternative when 100% foreign ownership is not allowed.

Answer: A

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

9) Greenfield investments are typically ________ and ________ than cross-border acquisition.

A) slower; more uncertain

B) faster; of greater certainty

C) slower; of greater certainty

D) faster; more uncertain

Answer: A

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

10) All of the following may be justification for a strategic alliance EXCEPT:

A) takeover defense.

B) a joint venture to pool resources for research and development.

C) joint marketing and serving agreements.

D) All of the above are legitimate reasons for strategic alliances.

Answer: D

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

11) In practice, when expanding into other countries, firms have been observed to follow a

sequential search pattern as described in the behavioral theory of the firm.

Answer: TRUE

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

12) As a general rule, the decision about where to invest abroad for the first time is the same as

the decision about where to reinvest abroad.

Answer: FALSE

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

13) Economists have observed that firms tend to invest first in countries that are too far distant in

psychic distance (similar cultural, legal, and institutional environment).

Answer: FALSE

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

14) Transnationals are firms that have operations in more than one country and conduct their

business through branches, foreign subsidiaries, or joint ventures with host country firms.

Answer: FALSE

Diff: 2

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

15) Licensing is a popular form of foreign investment because it does not need a sizable

commitment of funds, and political risk is often minimized.

Answer: TRUE

Diff: 1

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

16) MNEs typically used licensing with independent firms rather than with their own foreign

subsidiaries.

Answer: FALSE

Diff: 1

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

17) Joint ventures are a more common FDI than wholly owned subsidiaries.

Answer: FALSE

Diff: 1

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Recognition

AACSB: Application of knowledge

18) Local partners in a foreign country and in a joint venture with an MNE are likely to make

decisions that maximize the value of the subsidiary. Such actions probably will not maximize the

value of the entire firm.

Answer: TRUE

Diff: 1

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

19) The decision about where to invest abroad is influenced by behavioral factors. Explain the

behavioral approach to FDI.

Answer: The behavioral approach to analyzing the FDI decision is typified by the so-called

Swedish School of economists. The Swedish School has rather successfully explained not just

the initial decision to invest abroad, but also later decisions to reinvest elsewhere, and to change

the structure of a firm's international involvement over time. Based on the internationalization

process of a sample of Swedish MNEs, the economists observed that these firms tended to invest

first in countries that were not too far distant in psychic terms. Close psychic distance defined

countries with a cultural, legal, and institutional environment similar to Sweden's, such as

Norway, Denmark, Finland, Germany, and the United Kingdom. The initial investments were

modest in size, to minimize the risk of an uncertain foreign environment. As the Swedish firms

learned from their initial investments, they became willing to take greater risks with respect to

both the psychic distance of the countries, and the size of the investments.

Diff: 3

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

20) What are the advantages and disadvantages of serving a foreign market through a greenfield

foreign direct investment compared to an acquisition of a local firm in the target market?

Answer: A greenfield investment is defined as establishing a production or service facility

starting from the ground up, i.e., from a green field. Compared to greenfield investment, a cross-

border acquisition has a number of significant advantages. First and foremost, it is quicker.

Greenfield investment frequently requires extended periods of physical construction and

organizational development. By acquiring an existing firm, the MNE can shorten the time

required to gain a presence and facilitate competitive entry into the market. Second, acquisition

may be a cost-effective way of gaining competitive advantages such as technology, brand names

valued in the target market, and logistical and distribution advantages, while simultaneously

eliminating a local competitor. Third, international economic, political, and foreign exchange

conditions may result in market imperfections, allowing target firms to be undervalued. Many

enterprises throughout Asia have been the target of acquisition as a result of the Asian economic

crisis's impact on their financial health. Many enterprises were in dire need of capital injections

for competitive survival.

Cross-border acquisitions are not, however, without their pitfalls. As with all acquisitions—

domestic or international—there are the frequent problems of paying too high a price, or

suffering a method of financing that is too costly. Meshing different corporate cultures can be

traumatic. Managing the post-acquisition process is frequently characterized by downsizing to

gain economies of scale and scope in overhead functions. This results in nonproductive impacts

on the firm as individuals attempt to save their own jobs. Internationally, additional difficulties

arise from host governments intervening in pricing, financing, employment guarantees, market

segmentation, and general nationalism and favoritism. In fact, the ability to complete

international acquisitions successfully may itself be a test of the MNE's competence in the

twenty-first century.

Diff: 3

L.O.: 17.2 Structural Choices for Foreign Market Entry

Skill: Conceptual

AACSB: Application of knowledge

17.3 Political Risk: Definition and Classification

1) ________ risks are those that affect the MNE at the local or project level, but originate at the

country level.

A) Country-specific

B) Firm-specific

C) Global-specific

D) none of the above

Answer: A

Diff: 2

L.O.: 17.3 Political Risk: Definition and Classification

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT an example of a country-specific risk?

A) transfer risk

B) war and ethnic strife

C) cultural and religious heritage

D) All of the above are examples of country-specific risk.

Answer: D

Diff: 2

L.O.: 17.3 Political Risk: Definition and Classification

Skill: Recognition

AACSB: Application of knowledge

3) ________ is NOT one of the three main country-specific risks as outlined by your authors.

A) Transfer risk

B) Cultural differences

C) Thin equity base

D) Protectionism

Answer: C

Diff: 2

L.O.: 17.3 Political Risk: Definition and Classification

Skill: Recognition

AACSB: Application of knowledge

4) A number of institutional services provide updated country risk ratings on a regular basis. This

is an example of micro-risk information for MNEs using this data.

Answer: FALSE

Diff: 2

L.O.: 17.3 Political Risk: Definition and Classification

Skill: Recognition

AACSB: Application of knowledge

17.4 Financial Impacts of Political Risk

1) According to your authors, MNEs can anticipate government regulations that are

discriminatory or wealth depriving from a/an ________ or ________ level view.

A) foreign; domestic

B) micro; macro

C) internal; external

D) local; global

Answer: B

Diff: 2

L.O.: 17.4 Financial Impacts of Political Risk

Skill: Conceptual

AACSB: Application of knowledge

2) Of the following, which would NOT be considered an issue for an investment agreement prior

to investing in a foreign country?

A) the basis for setting transfer prices

B) the right to export to third-country markets

C) provision for arbitration of disputes

D) All of the above could be negotiated prior to investing.

Answer: D

Diff: 2

L.O.: 17.4 Financial Impacts of Political Risk

Skill: Conceptual

AACSB: Application of knowledge

3) ________ is the risk that the host government will take specific steps that prevent the foreign

affiliate from exercising control over the firm's assets.

A) Inconvertibility

B) Expropriation

C) Business income risk

D) none of the above

Answer: B

Diff: 1

L.O.: 17.4 Financial Impacts of Political Risk

Skill: Recognition

AACSB: Application of knowledge

17.5 Political Risk Mitigation

1) Blocked funds are cash flows that:

A) come in regular intervals in standardized amounts or blocks.

B) have been restricted in transfer out of a local country.

C) come from a certain sector or region of the world.

D) none of the above

Answer: B

Diff: 2

L.O.: 17.5 Political Risk Mitigation

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT one of the stages at which MNEs can react to the potential for

blocked funds?

A) prior to investing

B) during operations

C) reinvesting in the local country when funds cannot be moved

D) All of the above are stages at which MNEs can react.

Answer: D

Diff: 2

L.O.: 17.5 Political Risk Mitigation

Skill: Recognition

AACSB: Application of knowledge

3) A ________ loan, also known as ________ is a parent-to-affiliate loan channeled through a

financial intermediary such as a large commercial bank.

A) fronting; link financing

B) parallel; a back-to-back loan

C) fronting; a back-to-back loan

D) link financing; parallel loan

Answer: A

Diff: 2

L.O.: 17.5 Political Risk Mitigation

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT a typical characteristic of a fronting loan made to an

international subsidiary?

A) The parent makes a deposit equal to the size of the desired loan into a large commercial bank.

B) The bank lends to the subsidiary firm an amount equal to the parent deposit at a slightly

higher interest rate.

C) The lending bank is located in the subsidiary's country.

D) All of the above are typical characteristics of a fronting loan.

Answer: C

Diff: 2

L.O.: 17.5 Political Risk Mitigation

Skill: Recognition

AACSB: Application of knowledge

5) Which of the following could be considered an example of forced reinvestment if the

blockage of funds was expected to be temporary?

A) vertical reinvestment by an automobile manufacturer to buy parts suppliers and showrooms

B) a lumber cutting company subsequently builds a paper mill with blocked funds

C) purchase of local money market instruments and short-term loans

D) all of the above

Answer: C

Diff: 2

L.O.: 17.5 Political Risk Mitigation

Skill: Conceptual

AACSB: Application of knowledge

6) OPIC stands for:

A) Organization for the Prevention of Insufficient Capitalization.

B) Organization of Petroleum Importing Countries.

C) Overseas Private Investment Corporation.

D) Overseas Public Insurance Commission.

Answer: C

Diff: 2

L.O.: 17.5 Political Risk Mitigation

Skill: Recognition

AACSB: Application of knowledge

7) ________ is a type of political risk that OPIC does NOT cover.

A) Inconvertibility

B) Expropriation

C) War

D) OPIC covers all of the above.

Answer: D

Diff: 2

L.O.: 17.5 Political Risk Mitigation

Skill: Recognition

AACSB: Application of knowledge

8) A country can react to the potential for blocked funds prior to making an investment, during

operations, or by investing in the local country in assets than maintain their value.

Answer: TRUE

Diff: 1

L.O.: 17.5 Political Risk Mitigation

Skill: Conceptual

AACSB: Application of knowledge

9) Banks are very hesitant to engage in fronting loans because of the low probability of

repayment and thus their risk exposure up to a 100% loss.

Answer: FALSE

Diff: 1

L.O.: 17.5 Political Risk Mitigation

Skill: Conceptual

AACSB: Application of knowledge

10) What are blocked funds? List and explain two of the three methods the authors list in this

chapter for dealing with blocked funds.

Answer: Blocked funds are those that have been restricted from foreign exchange in some

fashion by the government of the host country. If this is a potential problems firms take a number

of steps to reduce or minimize the impact of such a governmental action. In this chapter the

authors identify three techniques for dealing with the problem of blocked funds. First, using

fronting loans. Here the firm deposits money into a large financial institution, typically in a

neutral third country, and then has the bank loan the same amount to the foreign subsidiary.

There are several reasons why governments are more likely to allow repayments of such loans as

opposed to repayment to the parent.

Second, the local firm may create new exports thus increasing the flow of currency into the

country and achieving the goals of the government. Third, the authors also mention a special

dispensation whereby firms in highly desirable and specialized industries such as

telecommunications or pharmaceuticals are contractually guaranteed repatriation of funds at a

greater rate than normal.

Diff: 3

L.O.: 17.5 Political Risk Mitigation

Skill: Conceptual

AACSB: Application of knowledge

11) An investment agreement spells out specific rights and responsibilities of both the foreign

firm and the host government. What are the main financial policies that should be included in an

investment agreement?

Answer: An investment agreement spells out specific rights and responsibilities of both the

foreign firm and the host government. The presence of MNEs is as often sought by development-

seeking host governments as a particular foreign location is sought by an MNE. All parties have

alternatives, and so bargaining is appropriate. An investment agreement should spell out policies

on financial and managerial issues, including the following:

- The basis on which fund flows, such as dividends, management fees, royalties, patent fees, and

loan repayments, may be remitted.

- The basis for setting transfer prices.

- The right to export to third-country markets.

- Obligations to build, or fund, social and economic overhead projects, such as schools, hospitals,

and retirement systems.

- Methods of taxation, including the rate, the type of taxation, and means by which the rate base

is determined.

- Access to host-country capital markets, particularly for long-term borrowing.

- Permission for 100% foreign ownership versus required local ownership (joint venture)

participation.

- Price controls, if any, applicable to sales in the host-country markets.

- Requirements for local sourcing versus import of raw materials and components.

- Permission to use expatriate managerial and technical personnel, and to bring them and their

personal possessions into the country free of exorbitant charges or import duties.

- Provision for arbitration of disputes.

- Provisions for planned divestment, should such be required, indicating how the going concern

will be valued and to whom it will be sold.

Diff: 3

L.O.: 17.5 Political Risk Mitigation

Skill: Conceptual

AACSB: Application of knowledge

Multinational Business Finance, 15e (Eiteman/Stonehill/Moffett)

Chapter 18 Multinational Capital Budgeting and Cross-Border Acquisitions

18.1 Complexities of Budgeting for a Foreign Project

1) The traditional financial analysis applied to foreign or domestic projects, to determine the

project's value to the firm is called:

A) cost of capital analysis.

B) capital budgeting.

C) capital structure analysis.

D) agency theory.

Answer: B

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following is NOT a basic step in the capital budgeting process?

A) Identify the initial capital invested.

B) Estimate the cash flows to be derived from the project over time.

C) Identify the appropriate interest rate at which to discount future cash flows.

D) All of the above are steps in the capital budgeting process.

Answer: D

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

3) Of the following capital budgeting decision criteria, which does NOT use discounted cash

flows?

A) net present value

B) internal rate of return

C) accounting rate of return

D) All of these techniques typically use discounted cash flows.

Answer: C

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT a reason why capital budgeting for a foreign project is more

complex than for a domestic project?

A) Parent cash flows must be distinguished from project cash flows.

B) Parent firms must specifically recognize remittance of funds due to differing rules and

regulations concerning remittance of cash flows, taxes, and local norms.

C) Differing rates of inflation exist between the foreign and domestic economies.

D) All of the above add complexity to the international capital budgeting process.

Answer: D

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

5) For purposes of international capital budgeting, which of the following statements is NOT

true?

A) Managers must evaluate political risk because political events can drastically reduce the value

or availability of expected cash flows.

B) Parent cash flows must be distinguished from project cash flows. Each of these two types of

flows contributes to a different view of value.

C) An array of nonfinancial payments can generate cash flows from subsidiaries to the parent,

including payment of license fees and payments for imports from the parent.

D) All of the above are true statements.

Answer: D

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

6) Project evaluation from the ________ viewpoint serves some useful purposes and/but should

________ the ________ viewpoint.

A) local; be subordinated to; parent's

B) local; not be subordinated to; parent's

C) parent's; be subordinated to; local

D) none of the above

Answer: A

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

7) For financial reporting purposes, U.S. firms must consolidate the earnings of any subsidiary

that is over ________ owned.

A) 20%

B) 40%

C) 50%

D) 75%

Answer: C

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

8) A foreign firm that is 20% to 49% owned by a parent is called a/an:

A) subsidiary.

B) affiliate.

C) partner.

D) rival.

Answer: B

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

9) Affiliate firms are consolidated on the parent's financial statements on a ________ basis.

A) pro rated

B) 50%

C) 75%

D) 100%

Answer: A

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

10) When engaged in international capital budgeting, the analyst must identify the initial amount

of capital invested or put at risk.

Answer: TRUE

Diff: 1

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

11) In international capital budgeting, the appropriate discount rate for determining the present

value of the expected cash flows is always the firm's domestic WACC.

Answer: FALSE

Diff: 1

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Conceptual

AACSB: Application of knowledge

12) For purposes of international capital budgeting, it is NOT important to distinguish between

parent and total project cash flows.

Answer: FALSE

Diff: 1

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Conceptual

AACSB: Application of knowledge

13) For purposes of international capital budgeting, parent cash flows often depend on the form

of financing. Thus, we cannot clearly separate cash flows from financing decisions, as we can in

domestic capital budgeting.

Answer: TRUE

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

14) There are no important differences between domestic and international capital budgeting

methods.

Answer: FALSE

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

15) It is important that firms adopt a common standard for the capital budgeting process for

choosing among foreign and domestic projects.

Answer: TRUE

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

16) The only proper way to estimate the NPV of a foreign project is to discount the appropriate

cash flows first and then convert them to the domestic currency at the current spot rate.

Answer: FALSE

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Conceptual

AACSB: Application of knowledge

17) For purposes of international capital budgeting, evaluation of a project from the PARENT

viewpoint serves some useful purposes, but it should be subordinated to evaluation from the

LOCAL's viewpoint.

Answer: FALSE

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Recognition

AACSB: Application of knowledge

18) Multinational firms should invest only if they can earn a risk-adjusted return greater than

locally based competitors can earn on the same project.

Answer: TRUE

Diff: 2

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Conceptual

AACSB: Application of knowledge

19) The authors highlight a strong theoretical argument in favor of analyzing any foreign project

from the viewpoint of the parent. Provide at least three reasons why the parent's viewpoint is

superior to the local viewpoint and give an example of when the local viewpoint fails to

maximize the value of the firm.

Answer: A project might have a positive NPV from the local viewpoint, but fail to consider

relevant cash flows from the parent viewpoint. For example, a positive NPV project in one

country may result from the erosion of revenues in another. A local manager would not

necessarily be expected to be aware of such erosion. It may not be possible to remit all or part of

the local cash flows to the parent company and reinvestment opportunities in the local economy

may be inferior to what the parent could do elsewhere, thus, a less than maximum use of funds.

Political and exchange rate risk add to the uncertainty of cash flows and thus increase the

required rate of return by stockholders. Cash flows may be more difficult to estimate especially

long-term cash flows in lesser-developed countries.

Diff: 3

L.O.: 18.1 Complexities of Budgeting for a Foreign Project

Skill: Conceptual

AACSB: Application of knowledge

18.2 Illustrative Case: Cemex Enters Indonesia

1) Which of the following is NOT an example of political risk?

A) Expropriation of cash flows by a foreign government.

B) The U.S. government restricts trade with a foreign country where your firm has investments.

C) The foreign government nationalizes all foreign-owned assets.

D) All of the above are examples of political risk.

Answer: D

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

2) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of

6% in Norway and 3% per annum in the U.S., use the formula for relative purchasing power

parity to estimate the one-year spot rate of krone per dollar.

A) 7.87 krone per dollar

B) 8.10 krone per dollar

C) 8.34 krone per dollar

D) There is not enough information to answer this question.

Answer: C

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Analytical

AACSB: Analytical thinking

3) When evaluating capital budgeting projects, which of the following would NOT necessarily

be an indicator of an acceptable project?

A) an NPV > $0

B) an IRR > the project's required rate of return

C) an IRR > $0

D) All of the above are correct indicators.

Answer: C

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

4) Given a current spot rate of 8.10 Norwegian krone per U.S. dollar, expected inflation rates of

3% in Norway and 6% per annum in the U.S., use the formula for relative purchasing power

parity to estimate the one-year spot rate of krone per dollar.

A) 7.87 krone per dollar

B) 8.10 krone per dollar

C) 8.34 krone per dollar

D) There is not enough information to answer this question.

Answer: A

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Analytical

AACSB: Analytical thinking

5) When determining a firm's weighted average cost of capital (WACC), which of the following

terms is NOT necessary?

A) the firm's tax rate

B) the firm's cost of debt

C) the firm's cost of equity

D) All of the above are necessary.

Answer: D

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

6) When determining a firm's weighted average cost of capital (WACC), which of the following

terms is NOT necessary?

A) the firm's weight of equity financing

B) the risk-free rate of return

C) the firm's weight of debt financing

D) All of the above are necessary to determine a firm's WACC.

Answer: B

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

Instruction 18.1:

Use the information to answer the following question(s).

The Velo Rapid Revolutions Inc., a company that produces bicycles, elliptical trainers, scooters

and other wheeled non-motorized recreational equipment, is considering an expansion of their

product line to Europe. The expansion would require a purchase of equipment with a price of

€1,200,000 and additional installation of €300,000 (assume that the installation costs cannot be

expensed, but rather, must be depreciated over the life of the asset). Because this would be a new

product, they will not be replacing existing equipment. The new product line is expected to

increase revenues by €600,000 per year over current levels for the next 5 years, however;

expenses will also increase by €200,000 per year. (Note: Assume the after-tax operating cash

flows in years 1-5 are equal, and that the terminal value of the project in year 5 may change total

after-tax cash flows for that year.) The equipment is multipurpose and the firm anticipates that

they will sell it at the end of the five years for €500,000. The firm's required rate of return is 12%

and they are in the 40% tax bracket. Depreciation is straight-line to a value of euro 0 over the 5-

year life of the equipment, and the initial investment (at year 0) also requires an increase in NWC

of €100,000 (to be recovered at the sale of the equipment at the end of five years). The current

spot rate is $0.95/euro, and the expected inflation rate in the U.S. is 4% per year and 3% per year

in Europe.

7) Refer to Instruction 18.1. What is the initial investment for the Velo Rapid Revolutions

project?

A) $1,500,000

B) €1,600,000

C) $1,600,000

D) €1,500,000

Answer: A

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Analytical

AACSB: Analytical thinking

8) Refer to Instruction 18.1. What are the annual after-tax cash flows for the Velo Rapid

Revolutions project?

A) €400,000

B) €240,000

C) €120,000

D) €360,000

Answer: D

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Analytical

AACSB: Analytical thinking

9) Refer to Instruction 18.1. What is the NPV of the European expansion if Velo Rapid

Revolutions first computes the NPV in euros and then converts that figure to dollars using the

current spot rate?

A) $1,520,000

B) $1,684,210

C) -$75,310

D) -$71,544

Answer: D

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Analytical

AACSB: Analytical thinking

10) Refer to Instruction 18.1. In euros, what is the NPV of the Velo Rapid Revolutions

expansion?

A) €1,524,690

B) $1,611,317

C) -€75,310

D) -€111,317

Answer: C

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Analytical

AACSB: Analytical thinking

11) Refer to Instruction 18.1. What is the IRR of the Velo Rapid Revolutions expansion?

A) 14.4%

B) 10.3%

C) 12.0%

D) 8.6%

Answer: B

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Analytical

AACSB: Analytical thinking

12) If a firm undertakes a project with ordinary cash flows and estimates that the firm has a

positive NPV, then the IRR will be:

A) less than the cost of capital.

B) greater than the cost of capital.

C) greater than the cost of the project.

D) cannot be determined from this information

Answer: B

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

13) When estimating a firm's cost of equity capital using the CAPM, you need to estimate:

A) the risk-free rate of return.

B) the expected return on the market portfolio.

C) the firm's beta.

D) all of the above

Answer: D

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

14) ________ is the risk that a foreign government will place restrictions such as limiting the

amount of funds that can be remitted to the parent firm, or even expropriation of cash flows

earned in that country.

A) Exchange risk

B) Foreign risk

C) Political risk

D) Unnecessary risk

Answer: C

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

15) Generally speaking, a firm wants to receive cash flows from a currency that is ________

relative to their own, and pay out in currencies that are ________ relative to their home currency.

A) appreciating; depreciating

B) depreciating; depreciating

C) appreciating; appreciating

D) depreciating; appreciating

Answer: A

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Conceptual

AACSB: Application of knowledge

16) When assessing the additional risk that can occur from investing abroad, firms may choose to

account for risk via:

A) adjusting the cash flows.

B) adjusting the discount rates.

C) adjusting both cash flows and discount rates.

D) adjusting all of the above.

Answer: D

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

17) When a multinational firm invests abroad, it is common to develop two capital budgets: one

from the project viewpoint, and one from the parent viewpoint.

Answer: TRUE

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

18) When estimating a capital budget, it is common to separate cash flows into: 1) the initial

investment, 2) incremental cash flows over the life of the project, and 3) a terminal value.

Answer: TRUE

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

19) Because international capital budgeting is so difficult, time consuming, expensive, and

uncertain, firms generally forego any type of additional sensitivity analysis after completing a

base-case scenario.

Answer: FALSE

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Conceptual

AACSB: Application of knowledge

20) A criticism of adjusting the discount rate to account for political risk is that adjusting the

discount rate for political risk penalizes early cash flows too heavily while not penalizing distant

cash flows enough.

Answer: TRUE

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Recognition

AACSB: Application of knowledge

21) When dealing with international capital budgeting projects, the value of the project is NOT

sensitive to the firm's cost of capital.

Answer: FALSE

Diff: 2

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Conceptual

AACSB: Application of knowledge

22) Explain how political risk and exchange rate risk increase the uncertainty of international

projects for the purpose of capital budgeting.

Answer: The evaluation of foreign projects must consider several risks that are either

nonexistent or much less important in domestic capital budgeting. First, if revenues and expenses

are in a foreign currency, then the parent firm must estimate the exchange rate at which the

foreign currency will be converted into the domestic currency. To estimate future exchange rates,

the parent firm must estimate expected rates of inflation and interest rates in both countries,

economic growth in each country, as well as consumer preferences and tastes in more than one

country. Then, aspects of political risk must be considered. What is the likelihood that all or part

of the cash flows accruing to the parent firm will be restricted through some political act? The

firm must now consider the possibility of changing tax rates, new taxes, and additional

restrictions on the flow of funds. Furthermore, local norms may differ from usual firm practice in

terms of financing or dividend policy. Domestic capital budgeting may seem quite easy in

comparison.

Diff: 3

L.O.: 18.2 Illustrative Case: Cemex Enters Indonesia

Skill: Conceptual

AACSB: Application of knowledge

18.3 Real Option Analysis

1) Real option analysis allows managers to analyze all of the following EXCEPT:

A) the option to defer.

B) the option to abandon.

C) the option to alter capacity.

D) All of the above may be analyzed using real option analysis.

Answer: D

Diff: 2

L.O.: 18.3 Real Option Analysis

Skill: Recognition

AACSB: Application of knowledge

2) Real option analysis treats cash flows in terms of future value in a positive sense, whereas

DCF treats future cash flows negatively.

Answer: TRUE

Diff: 1

L.O.: 18.3 Real Option Analysis

Skill: Conceptual

AACSB: Application of knowledge

3) Real option analysis is a particularly powerful device when addressing potential investment

projects with extremely long life spans or investments that do not commence until future dates.

Answer: TRUE

Diff: 1

L.O.: 18.3 Real Option Analysis

Skill: Conceptual

AACSB: Application of knowledge

4) What is real option analysis? How is it a better method of making investment decisions than

using traditional capital budgeting analysis?

Answer: Real options is a different way of thinking about investment values. At its core, it is a

cross between decision-tree analysis and pure option-based valuation. It is particularly useful

when analyzing investment projects that will follow very different value paths at decision points

in time where management decisions are made regarding project pursuit. This wide range of

potential outcomes is at the heart of real option theory. Real option valuation also allows us to

analyze a number of managerial decisions that in practice characterize many major capital

investment projects:

1. The option to defer

2. The option to abandon

3. The option to alter capacity

4. The option to start up or shut down (switching)

Real option analysis treats cash flows in terms of future value in a positive sense, whereas DCF

treats future cash flows negatively (on a discounted basis). Real option analysis is a particularly

powerful device when addressing potential investment projects with extremely long life spans or

investments that do not commence until future dates.

Real option analysis acknowledges the way information is gathered over time to support

decision-making. Management learns from both active (searching it out) and passive (observing

market conditions) knowledge-gathering and then uses this knowledge to make better decisions.

Diff: 2

L.O.: 18.3 Real Option Analysis

Skill: Conceptual

AACSB: Application of knowledge

18.4 Project Financing

1) Which of the following is NOT a factor critical to the success of project financing?

A) separability of the project from its investors

B) long-lived and capital intensive singular projects

C) cash flow predictability from third part commitments

D) All of the above are critical factors for project financing.

Answer: D

Diff: 2

L.O.: 18.4 Project Financing

Skill: Conceptual

AACSB: Application of knowledge

2) Which of the following is NOT a characteristic of international long-term capital project

financing?

A) The projects are large in scale.

B) The projects are long in life.

C) The projects are generally high in risk.

D) The projects may be all of the above.

Answer: D

Diff: 2

L.O.: 18.4 Project Financing

Skill: Recognition

AACSB: Application of knowledge

3) The predictability of the project's revenue stream is essential in securing project financing.

Which of the following is NOT a typical contract provisions that are intended to assure adequate

cash flow?

A) quantity and quality of the project's output

B) a pricing formula

C) circumstances that permit changes in the contract

D) fronting loan

Answer: D

Diff: 2

L.O.: 18.4 Project Financing

Skill: Recognition

AACSB: Application of knowledge

4) Project financing is the arrangement of financing for very large individual long-term capital

projects.

Answer: TRUE

Diff: 1

L.O.: 18.4 Project Financing

Skill: Recognition

AACSB: Application of knowledge

5) Debt is usually a large component of project financing.

Answer: TRUE

Diff: 1

L.O.: 18.4 Project Financing

Skill: Recognition

AACSB: Application of knowledge

6) The level of debt places an enormous burden on cash flow for debt service and requires a

number of additional levels of risk reduction.

Answer: TRUE

Diff: 1

L.O.: 18.4 Project Financing

Skill: Recognition

AACSB: Application of knowledge

7) In project finance, retained earnings and the reinvestment of earnings are the most important

decisions to guarantee the long-term growth of the project's value.

Answer: FALSE

Diff: 1

L.O.: 18.4 Project Financing

Skill: Recognition

AACSB: Application of knowledge

18.5 Cross-Border Mergers and Acquisitions

1) Which of the following is NOT a reason given for international mergers and acquisitions?

A) gaining access to strategic proprietary assets

B) gaining market power and dominance

C) diversifying and spreading their risks wider

D) All of the above are commonly cited reasons for international mergers and acquisitions.

Answer: D

Diff: 2

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge

2) Which of the following changes does NOT create business opportunities for select firms to

both enhance and defend their competitive positions in global markets?

A) changes in technology

B) changes in regulation

C) changes in capital markets

D) changes in management

Answer: D

Diff: 2

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge

3) The process of acquiring an enterprise anywhere in the world has three common elements

EXCEPT:

A) identification and valuation of the target.

B) execution of the acquisition offer and purchase—the tender.

C) management of the post-acquisition transition.

D) All of the above are common elements in acquiring an enterprise anywhere in the world.

Answer: D

Diff: 2

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge

4) Which of the following is NOT an advantage of cross-border acquisitions over greenfield

investments?

A) quicker

B) cost-effective

C) target firms to be undervalued

D) melding corporate cultures

Answer: D

Diff: 2

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge

5) Which of the following is NOT a typical pitfall of cross-border acquisitions?

A) paying too much

B) excessive financing costs

C) melding corporate cultures

D) all of the above are pitfalls

Answer: D

Diff: 2

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge

6) Currency risk is a concern for any international merger and acquisition activity. For instance,

the initial bid, if denominated in a foreign currency, creates a contingent foreign currency

exposure for the bidder.

Answer: TRUE

Diff: 1

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Conceptual

AACSB: Application of knowledge

7) Currency risk is a concern for any international merger and acquisition activity. For instance,

once the bidder has successfully won the acquisition, the exposure evolves from a transaction

exposure to a contingent exposure.

Answer: FALSE

Diff: 1

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge

8) The drivers of international merger and acquisitions are only MACRO in scope.

Answer: FALSE

Diff: 1

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge

9) As opposed to greenfield investment, a cross-border acquisition is typically quicker.

Answer: TRUE

Diff: 1

L.O.: 18.5 Cross-Border Mergers and Acquisitions

Skill: Recognition

AACSB: Application of knowledge